How to consolidate credit card debt

When you have multiple credit cards with balances with different interest rates, you may want to consider consolidating your credit card debt. 

Combining all your credit card debts into one lump sum can simplify your monthly payments, provide you with a more clear path to becoming debt-free, and possibly save you money if you move your debts to a card with a lower APR.

What is debt consolidation?

Debt consolidation involves combining multiple debts into one new loan or credit line. This can be especially helpful for the following reasons:

• You can reduce multiple monthly bill payments into one monthly payment.
• You may save money with a lower interest rate than your current credit card APRs.
• You could have a set payoff date.
• Your new monthly payment could be the same amount every month.
• Your credit score may increase as your revolving debt load decreases.

For example, let’s say you have three credit cards with balances totaling $7,000 with interest rates ranging from 16.99% to 24.99%. If you can qualify for a debt consolidation loan offering a 7% APR for a three-year term, more of your payment will go toward the principal of the debt rather than principal plus interest, you’ll have just one payment to make, and you’ll know exactly when you’ll have that debt paid off. 

Plus, your credit score may see a nice bump after using loan proceeds to pay off your credit card balances. 

Why would you consolidate your credit card debt?

“Paying your bills can feel overwhelming and tedious if you have multiple credit cards on top of your other monthly expenses. When you consolidate your debt, you combine several bills into one, meaning you’ll have fewer accounts to manage,” says Leslie H. Tayne, a financial attorney who specializes in debt and is the founder and managing director of the New York-based Tayne Law Group, P.C.

Deciding how much to pay on which card can also keep you from formulating a repayment plan when dealing with multiple balances across several cards. Plus, added interest charges assessed on revolving balances make it even more difficult to dig out of credit card debt.

That’s why it may be time to consider consolidating those debts into one, leaving you with one bill to pay every month — at a possibly lower interest rate — with a fixed repayment period. That way, you have a much clearer picture of when you’ll actually achieve your goal of being debt-free.

Ways to consolidate credit card debt

There are four conventional options to consolidate your credit card debt:

• You can apply for a personal loan (also sometimes referred to as a debt consolidation loan) from a bank or credit union.
• You can consolidate your card debt with a balance transfer credit card.
• If you have a lot of equity in your home, you could look into a cash-out refinance loan or home equity loan.
• You can visit a local credit counseling agency to see if you qualify for a debt management plan.

Another option is to borrow against a retirement account, such as your 401(k), but doing so can derail your retirement goals.

How do you consolidate credit card debt?

Several factors will play into which debt consolidation option is best for you, including how much debt you have, what you can afford to pay every month, what your credit score is and what interest rate the new loan may carry.

Personal loan or debt consolidation loan

You can choose to apply for a personal loan or credit card consolidation loan from a bank or credit union. A credit card debt consolidation loan is basically the same as a personal loan, but banks or credit unions may advertise their loans as debt consolidation loans to attract customers saddled with credit card debt. 

Pros and cons of a debt consolidation or personal loan

Pros

• Loan amount can be higher than what you could get with a balance transfer card.
• Fixed monthly payment.
• Fixed amount of time to pay off the loan, giving you an end date for when you’ll be out of debt.
• Lower credit score requirements for approval.
• A personal loan can boost your credit score if managed responsibly.

Cons

• Interest rates may be high and will depend on your credit score.
• To get a manageable payment, you may have to extend the loan term.
• There may be fees involved, such as a loan origination fee or late payment fees.

It’s important to do some research to find lenders offering the lowest interest rates. Know that lenders will typically post an APR range for their loans. Generally, the higher your credit score, the lower your APR will be. Personal loans tend to be unsecured loans (meaning you aren’t tying the loan to collateral, such as your home or auto), so their APRs can be higher than a secured loan, where your home or car serves as collateral if you default on payments.

The benefit of moving multiple credit card debts into one loan is that doing so can improve your credit score as you use the loan proceeds to pay off your credit card balances. 

High credit card utilization ratios (the percentage of debt you are carrying vs. your card’s credit limit) can drag down your credit score. Zeroing out those debts can give your score an instant credit score boost, as long as you don’t start adding a large balance back to the cards once you’ve paid them off.

Plus, credit utilization only applies to revolving credit (such as credit cards) and not personal loans (which are considered installment credit). So, the balance of your loan won’t impact your credit utilization ratio.

Know that you can stretch your loan repayment period out over several years to achieve a lower monthly payment, but the longer the loan term, the more you will end up paying in interest charges. 

Balance transfer credit card

Balance transfer credit cards typically offer an introductory low or no-interest period that can be as short as six months or as long as almost two years. This can give you a helping hand toward paying down your debt as your payments during the promotional period will go entirely toward your principal. Any remaining balance not paid off during the promotional period will be subject to that card’s ongoing interest rate.

A balance transfer card is better suited for consumers with higher credit scores and lower debt amounts, as balance transfer credit lines may not be large enough to absorb multiple high credit card balances and these cards may require credit scores in the very-good-to excellent-range, which FICO typically defines as 740 to 850.

Once approved for a balance transfer card, you direct the issuer on which card balances you want to pay off with your new line of credit. Note that issuers typically restrict you from transferring a balance between cards from the same issuer. For example, you can’t transfer debt from an existing Bank of America credit card to a new Bank of America balance transfer card.

Pros and cons of a balance transfer card

Pros

• Interest-free promotional periods.
• Long-term credit score improvement as card balances are paid off.
• Consolidate multiple credit card balances into one.
• Flexible payments. You can pay as much as you want one month or just pay the minimum amount due another month (but paying just the minimum won’t make much of a dent in your efforts to get out of debt).

Cons

• Balance transfer fees can range from 3% to 5% of each amount transferred.
• Short-term credit score damage as the new balance transfer card will have a high balance and you’ll likely have a hard inquiry added to your credit report.
• Credit line may not be large enough to accommodate all your card debt.
• If you can’t pay off the transferred balance within the promotional period, you’ll be hit with interest charges on any remaining balance.

When comparing balance transfer credit cards, you’ll need to consider whether you will be able to pay the bulk of your debt off during the promotional period time frame, whether your existing card debt is on a card from the same issuer of the card you’re looking to transfer debt to, what the balance transfer fees are, and what the ongoing APR range will be once the promotional period expires.

Balance transfer cards are best for those with great credit, who have the discipline to pay off the transferred balance within the promotional period and who aren’t looking to transfer huge balances that may exceed the credit limit provided to you by the issuer of the new balance transfer card. Otherwise, you may end up having to apply for multiple balance transfer cards, thereby defeating the goal of having one card payment every month.

Cash-out refinance loan or home equity loan

A cash-out refinance or home equity loan can be a good option for those who have a lot of equity built up in their home. These are considered secured loans since your home serves as collateral and, as such, tend to have lower interest rates than a personal loan. However, if you repeatedly miss payments, your home can be at risk of repossession for non-payment.

A cash-out refinance is essentially taking out a whole new mortgage on your home in an amount over and above what you currently owe and use that extra cash to pay off your debts (or home repairs, student loans, etc.). The new mortgage then takes the place of the old mortgage.

Pros and cons of a cash-out refinance

Pros

• Lower interest rates.
• Fixed monthly payment.
• Fixed interest rate.
• Long repayment terms.

Cons

• You may have to pay closing costs and related fees.
• Slow processing time as appraisals and loan docs are prepared.
• You restart the clock on paying off your home.
• You risk repossession if you fail to make payments in a timely manner.

A home equity loan differs from a cash-out refinance in that a home equity loan or line of credit is considered a second mortgage rather than replacing your current mortgage with a new one, meaning you’ll have two payments instead of just one.

Generally, the guidelines for a home equity loan or line of credit allow you to access up to 85% of the equity you have built up in your home. For example, if you have a home that’s worth $500,000 and you owe $250,000, you will typically only be allowed to borrow up to 85% of the amount over and above what you still owe, or roughly $200,000.

And unlike home equity loans, a home equity line of credit typically carries a variable interest rate rather than a fixed interest rate. Variable interest rates can go up or down when the Federal Reserve raises or lowers the federal funds rate.

Finally, know that lenders will take into account your credit standing, employment, income and debt-to-income ratio when evaluating your creditworthiness for these types of secured loans.

Debt management plans

Debt management plans (DMP) are offered through credit counseling organizations for people overburdened with unsecured debts, such as credit card debt, and who may not be able to qualify for a loan or balance transfer credit card. You will be required to meet with a credit counselor to go over your financial situation to see if you qualify for a DMP.

With a DMP, the credit counseling organization will negotiate your debts with your creditors and may be able to lower your interest rates and eliminate any fees. DMPs typically range from three to five years, and you’ll make a single monthly payment to the credit counselor (plus a small monthly fee), who will then make creditor payments on your behalf.

When seeking a credit counseling agency to work with, it’s smart to ensure you’re dealing with a reputable nonprofit rather than a for-profit company — and don’t confuse a debt management plan with more risky debt settlement. The latter service is often advertised by shady companies that will advise you to stop paying your creditors, and can severely damage your credit standing.

Pros and cons of debt management plans

Pros

• Credit counseling agencies can negotiate APRs and fees.
• Professional advice and review of your finances.
• Card accounts can be “re-aged,” bringing delinquent accounts current.
• Any collection calls should stop after accounts are brought current.

Cons

• DMP fees typically include a one-time setup fee and monthly fee.
• All your card accounts included in the DMP are closed.
• Your credit reports will reflect that you’re participating in a DMP, potentially affecting your ability to access credit.

If you do decide to visit a nonprofit credit counselor, you should be able to find an agency that is a member of the National Foundation for Credit Counseling or the Financial Counseling Association of America.

Is consolidating your credit card debt a good idea?

Yes, if you find yourself struggling to manage multiple credit card balances with high interest rates, consolidating those debts into one loan or line of credit can simplify your financial life. 

Plus, you may be able to save money if you find a debt consolidation option that carries a lower interest rate than what you are currently paying on your credit cards. 

Depending on which option you choose to consolidate your debt, you may be able to improve your credit standing as those high revolving card balances are paid off. 

The biggest risk people face when consolidating credit card balances is being able to avoid the temptation to rack up new purchases on those old cards that may now have zero balance. 

Frequently asked questions (FAQs)

What is a credit card consolidation loan?

A credit card consolidation loan is just another term for a personal loan. Such a loan can be used to pay off credit card debt at a fixed rate for a fixed amount of time.

Can I consolidate my credit card debt on my own?

Yes, you can consolidate credit card debt on your own by applying for a balance transfer card. If you have substantial personal savings, you can pay off your credit card debts with those funds as well. You can also apply for a personal loan (sometimes called a debt consolidation loan) to consolidate your credit card debt on your own.

Is taking out a loan to consolidate debt a good idea?

Taking out a loan to consolidate debt can be very helpful. A loan comes with a fixed payment with a fixed interest rate. When applying for a loan, you can often adjust the length of the loan term to create a monthly repayment amount that fits best with your budget. Plus, taking out a loan to pay off credit card debt can actually help your credit score.

Does consolidating your debt hurt your credit score?

In the short term, it might, but not in the long term. Wiping out debt should help your credit score improve. A personal loan will have the most immediate positive impact on your credit score.

A balance transfer card may hurt your credit initially when you move balances to it, but steady repayments will boost your score as the balance on your new card decreases. A home equity loan or line of credit shouldn’t negatively impact your score too much, but a debt management plan may have the most negative impact over time as card accounts are closed.