How to consolidate credit card debt

In a nutshell

Consolidating credit card debt involves taking out a new loan with a different lender to pay off existing credit card balances. You can combine the balances from several cards into one new balance with one monthly payment.

• Each debt consolidation option has its own advantages and drawbacks.
• Once you consolidate debt, manage the new loan and your original cards carefully.
• In addition to reducing interest fees, debt consolidation can expedite repayment, lower monthly payments, simplify debt management and result in a higher credit rating.

What does it mean to consolidate your credit cards?

Consolidating credit card debt involves taking out a new loan or a new credit card that pays off the outstanding balances of your existing credit card accounts. This can help streamline multiple high-interest payments into a single, lower monthly payment, making it easier to repay your debt.

For example, you may have three credit cards with various balances and interest rates. Your payments will depend on the amount you charge and owe month to month.

However, if you consolidate these debts with a consolidation loan, your credit card account balances will be paid in full. You’ll then make fixed-installment payments to a new lender until the loan balance is repaid.

Types of consolidation loans and options

Debt consolidation loans

A consolidation loan is specifically developed for debt consolidation. A lender approves you for a certain amount of money, and then you transfer the outstanding balances from other accounts to the new lender. Unlike a personal loan, you don’t have access to the money because it goes directly to the accounts you’re paying off.

Related: Best debt consolidation loans

Personal loans

Another option is to take out a personal loan to consolidate your debt. With this method, you apply for the loan amount you want and, if approved, the lender issues the loan as a lump sum. You’re responsible for using that money to pay your creditors directly.

Related: Best personal loans

Home equity loans and lines of credit

If you have a substantial amount of equity in your home, you may be able to tap a portion of its value with a home equity loan or home equity line of credit (HELOC). These are second-lien mortgages that use your home as collateral, so if you fail to repay them, you could lose your home to foreclosure.

Related: What is a home equity line of credit and how does it work?

You can use the cash from your home equity to pay off high-interest credit card debt, often with a much lower interest rate. Closing costs are usually included, which may be a flat fee or a percentage of the amount you borrow, such as 1% to 5%.

Interest on a home equity loan is typically fixed, while a HELOC usually has a variable rate. To qualify for a home equity loan or HELOC, you’ll need at least 15% to 20% equity in your home, a good credit score and a stable income and employment history.

401(k) loan

If you have a 401(k) plan, you may be able to borrow against your retirement savings. The loan rates are typically very low (the prime rate plus one percentage point), and the interest you pay is returned to your balance. Loan terms are typically five years.

Typically, you’ll have to count any untaxed amount of the 401(k) loan distribution as part of your gross income the year you take out the loan. You’ll also pay an additional 10% tax on the amount of the taxable distribution unless you’re at least age 59 ½, or qualify for another exception, according to the IRS.

A 401(k) loan is worth considering only if you have poor credit and wouldn’t otherwise qualify for other types of financing. However, this option depletes your retirement savings and you might face penalties if you don’t repay the loan balance on time. And if you leave your job, you may have to repay the loan balance in full.

Debt management plans

Nonprofit credit counseling agencies offer repayment plans to people who are struggling with their credit card bills. To qualify, you’ll need to have enough cash after paying your essential bills to meet the minimum payments on each of your accounts.

Under a debt management plan, you’ll make a single monthly payment to the agency, which will then distribute the money to your creditors. There is no loan involved, but you’re merging multiple payments into one. Many credit card companies lower the interest rates when you pay through such an agency, and plans are arranged to get you out of debt within three to five years.

Balance transfer credit cards

With a 0% APR balance transfer credit card, you can shift other credit card debt to the new account. Most charge a balance transfer fee of 2% to 5% of the total transfer amount. After that, you’ll have a fixed number of months to pay off the balance without interest. If any debt remains after that introductory period, the regular interest rate goes into effect.

Related: Best balance transfer credit cards with 0% APR

What is the difference between debt consolidation and credit card refinancing?

Debt consolidation involves loans. You can combine outstanding debt into one of the options listed above. The monthly payment is usually fixed, and the repayment terms are usually between two and five years. If you have a high credit score, you can snag a lower interest rate than many credit card companies charge. The new monthly payment may be higher or lower, depending on the new terms. Additionally, the consolidation lender may charge an origination fee, which is typically a couple of percentage points of the loan amount.

On the other hand, credit card refinancing is the transfer of credit card balances onto a credit card offering a better interest rate — usually 0% APR for at least one year. A balance transfer fee of 2% to 5% of the balance amount will be added to the amount you owe. If you pay your bill late or exceed your credit limit, the special introductory rate will most likely be nullified, and the regular interest rate goes into effect.

How does credit card consolidation work?

With a debt consolidation loan, the lender pays off your creditors. An advantage of this type of debt consolidation is that you know the money will be used to meet your financial obligations.

With a personal loan, you’ll pay your creditors directly once your lender issues you the loan proceeds. A personal loan works much the same as a debt consolidation loan, except it will be up to you to use the money to pay off your credit cards.

For example, if you have two credit cards, let’s see how a consolidation loan might benefit you:

• Card A: $5,000 balance, 21% APR, $138 monthly payment
• Card B: $6,000 balance, 28% APR, $200 monthly payment

This means your total debt is $11,000, your total monthly payments are $338, your payoff time is about 4.8 years. You’ll also pay $7,436.65 in total interest.

However, if you consolidate both balances into a new five-year consolidation loan with a 2% origination fee ($220) and an APR of 11%, you’ll pay a single monthly payment of $337.33 and total interest of $2,003.82. For roughly the same payment, you’ll save $5,433 in interest and get out of debt almost two years faster.

Be aware that the interest rate on both consolidation loans and personal loans is highly dependent on your credit score. If you have fallen behind on payments, or your credit utilization ratio is too high, you may not qualify for loans with advantageous interest rates.

How to consolidate credit card debt

There are several steps involved to consolidate your credit card debt:

• Gather all of your recent credit card statements. List who you owe, how much and what the APR is on each account.
• Research the loans that fit your financial and credit profile. Many lenders will do a soft credit pull, which won’t affect your credit score. By entering your basic information, they can determine if you prequalify and what terms to offer.
• Compare the amount you’ll save via consolidation with what you’re currently paying. Choose the loan that offers the best terms and most affordable payments you can easily handle.
• Apply for the consolidation loan. The application process will vary based on what type of loan you choose — home equity loans typically have the most amount of paperwork and financial hoops to jump through.
• If you’re approved, either supply the consolidation loan lender with your credit card account information or, if you’re getting a personal loan, pay off the debt with the funds you receive.

Common mistakes to avoid when consolidating credit card debt

The intention of debt consolidation is to solve a problem, not add to your troubles. The three most common mistakes borrowers make are:

• Applying for a financial product that doesn't match your credit profile: Make sure you are eligible for any loan you are considering, and that it’ll actually save you money.
• Falling behind on the new payments: Ensure that you can easily afford the payments on your new loan.
• Adding more debt on your cards: Once you’ve consolidated your credit card debt, avoid using your cards, otherwise, you’ll end up in the same position again.

Tips for successful credit card debt consolidation

Once you consolidate your credit card debt into a loan, take the following steps to ensure success:

• Enroll in automatic bill pay so you never miss a payment.
• Monitor your credit card accounts monthly for accuracy.
• Use your credit cards only when you know you can and will pay the balance in full.

The AP Buyline roundup

Consolidating credit card debt can be a powerful tool to reduce your interest rate and monthly payments — and potentially get you out of debt faster. Once you’ve successfully consolidated and paid off your credit cards, the positive account information is added to your credit report, boosting your credit scores. Watch out for consolidation fees and confirm that you can afford the new monthly payments.

Frequently asked questions (FAQs)

Will I lose my credit cards if I consolidate my debt?

Unless you close your credit card accounts, they will remain open. However, if you don’t use them and your account goes inactive for too long, some credit card issuers will cancel the account.

Does consolidating affect my credit score?

A new loan will appear on your credit report and will affect your credit history. However, when you exchange revolving debt for installment loans, typically, your credit rating will increase because it lowers your credit utilization ratio. Payment history is the most important credit scoring factor, so making on-time payments helps boost your score.

What credit score do you need to consolidate credit card debt?

Each lender has its own credit qualification standards. Some cater to people who have low credit scores, while others are focused on borrowers with excellent scores. However, the higher your credit scores are, the lower the interest rate will most likely be.

What happens if I miss a payment on a consolidation loan?

If you’re late on a loan payment, the lender may charge you a penalty. The lender will not notify the credit bureaus that you are delinquent unless you’re 30 days past due, which is then reflected on your credit report and can lower your credit score. Delinquencies remain on a credit report for seven years, but have the most significant impact within the first year.