Is Consolidating Credit Card Debt Worth It? Here's What to Consider

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Debt consolidation is one option for handling multiple credit card bills — but is it the right choice for you? While the advantages of consolidation include simplifying your finances and the opportunity to pay off debt more quickly, there are also disadvantages.

The main one is that debt consolidation can get you into a cycle of ever-increasing debt if you don’t handle it right. Consolidation alone won’t get to the root of why you’re having financial problems in the first place. You’ll also need to evaluate which consolidation option is right for your individual situation.

What is debt consolidation?

Debt consolidation involves taking out a new loan or balance transfer credit card that rolls your separate debts into a single monthly payment, usually at a lower interest rate. You then continue to pay the loan or balance transfer card as you would with any other financial obligation.

The difference is that you’re now dealing with your debt as one monthly bill, rather than a collection of separate payments. Also, if you’ve scored a lower interest rate, you’ll end up paying less money over the life of the debt than you would if you hadn’t consolidated.

However, this isn’t always as simple as it sounds. Some people who consolidate debt end up using their old credit cards again, racking up even more debt than before. You need to first take a look at your spending habits. If you’re spending more than you earn, consolidation isn’t going to get at the root of the problem. It’s best if you understand what caused your debt and have a plan to pay off the consolidation loan before you even get started.

Advantages of debt consolidation

  • You’ll have to make just one monthly payment.
  • Interest rates can be far lower than those imposed by regular credit cards.
  • A lower interest rate could reduce your monthly bill amount.
  • A lower interest rate may also help you pay off debt more quickly.
  • You could nail down a fixed – and thus more predictable – payment schedule.

Disadvantages of debt consolidation

  • Consolidation itself doesn’t solve the deeper source of your financial problems.
  • You could find yourself in even more debt if you continue to rack up balances on your credit cards.
  • You may be charged upfront costs when consolidating.
  • If you drag out payments for too long, you may end up spending more in interest.
  • Should you close your credit cards, your credit utilization rate will go up and your credit score may suffer.

Options for debt consolidation

When considering debt consolidation, make sure that you’re familiar with the variety of consolidation options available to you:

Balance transfer credit card

A balance transfer credit card allows you to transfer the debt from existing high-rate credit cards onto a card with a lower interest rate. These days, many balance transfer cards have no-interest introductory periods. If you have a good credit score, you could qualify for a balance transfer credit card with a 0% introductory period of as long as 21 months.

You’ll need to take into account that there is usually a fee to transfer your balance, which is generally about 3% to 5% of the transferred balance. Additionally, prior to transferring your balance, have a sense of how long it will take you to repay it. Once the intro period expires, the interest rate on your balance transfer card may be higher than your old cards. If you don’t pay off the debt by then, you could wind up paying even more interest than before.

Debt consolidation loan

A debt consolidation loan is a personal loan you use to pay off your credit cards. These loans are usually unsecured, with a fixed interest rate and a term of one to seven years. The interest rate on a debt consolidation loan may be lower than on a regular credit card, making this an attractive option if you don’t qualify for a 0% balance transfer card, or if you simply know you’ll need longer to pay off the debt than you’d get during the introductory period of a balance transfer card.

Debt consolidation loans often have origination fees, so you’ll need to keep that in mind when calculating whether you can save money by using one.

Home equity loan or home equity line of credit

Home equity loans (HELs) and home equity lines of credit (HELOCs) allow you to use your home equity — the value of your home minus what you still owe — as collateral. Because the loan or line of credit is secured by your property, the interest rate is often lower than that of other types of loans.

You receive a HEL as one lump sum with a fixed interest rate. A HELOC works a little differently — it has a variable interest rate and you can borrow against the line of credit much like you would with a credit card.

But keep in mind that should you not be able to repay the HEL or HELOC, the lender has the right to foreclose on your property. For this reason, most experts advise against using your home equity as collateral when consolidating unsecured credit card debt. In addition, note that both of these options carry fees, so be prepared to front that money if you go this route.

401(k) loan

If you’re considering tapping your 401(k) or other retirement accounts in order to manage your current debt, think twice. While this may seem like a wise move in what might feel like desperate times, you may ultimately feel the sting.

Keep in mind that taking out a loan from your 401(k) – while allowable – is not the same as making a withdrawal when you’re ready to retire. This is money that must be repaid with interest within five years.

There are limits on the amount you’ll be able to borrow and you’ll typically pay interest rates equal to the current prime rate, plus 1%. In addition, if you default or fail to pay back the loan within the five-year period, the loan will be considered an early distribution and you’ll pay a 10% penalty, plus income taxes on the loan amount. Additionally, should you lose your job, the loan may become due immediately.

If that’s not enough to deter you, remember that you’re borrowing from your retirement. You will lose the power of compounding earnings for the time that you borrow the money. Consider a retirement account loan as a last resort.

The bottom line

If you’re looking to consolidate your debt, you should weigh your options carefully with an eye toward what is most suitable for your personal financial circumstances. Keep in mind that taking on debt in a different package may not be the best choice for you in the long run.

There are also other ways to pay off credit card debt. Take the time to investigate and figure out what solution is most likely to get you out of debt in the long run.

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