Credit Card Debt Consolidation

    American consumers are traveling down a familiar path with credit card debt and now might be a good time to get familiar with the term credit card debt consolidation.

    A record-setting 178 million card owners owe a record-setting 1.023 trillion in credit card debt and both numbers are expected to increase in 2018. That comes to about four credit cards per family and the average household with credit card debt owes $16,048, which they obviously don’t have handy.

    What is Credit Card Debt Consolidation?

    Credit card debt consolidation is a way to take multiple bills from multiple card companies with multiple balances and multiple payment dates … and merge them into one payment with a whole lot less worries.

    Done properly, credit card consolidation will reduce the interest rate you pay on credit card debt, save you money and simplify your finances.

    Here’s how.

    Types of Credit Card Consolidation

    There are three ways to consolidate credit card debt: debt consolidation loans, debt management plans and debt settlement plans.

    Each form has pros and cons attached to it, depending on your resources, your discipline level and your desire to eliminate credit card debt. For most consumers, the credit card debt consolidation process is a 3-5 year program that should include a commitment to limited or no use of credit cards.

    Each one of the programs requires research. Like every project, it pays to do a little preparation work before diving in for a solution.

    Will Consolidation Save Me Money?

    The starting point for finding the best way to consolidate debt is to do a detailed examination of your budget. List all your sources of income and all expenses in as fine a detail as you can. This will allow you to answer questions and compare numbers among the various credit card debt consolidation options.

    When you do the detailed examination of your budget, one stopping point is to look at how much interest you are paying on credit card debt and whether you have sufficient income to pay it off with no help.

    Most people think when they’ve gotten too far in debt, they must be paying a high-interest penalty and that probably is the case. However, it could also be that you had really good interest rates, then got in the bad habit of making only minimum monthly payments and companies responded by raising interest rates.

    However, if you have enough income to pay down the debts and start doing so every month, your card company could change its tune. They don’t want to lose your business so it might just take a phone call asking for lower interest rates to get relief for your debts.

    If that’s the case, the DIY (do it yourself) program could allow you to pay down debts over time without outside help. That’s the ideal solution, but obviously not the one most people will use.

    Credit Card Consolidation Loans

    The most popular choice to consolidate credit card debt is by taking out a single loan to pay off all your credit card debt and then repay the new loan.

    A successful debt consolidation loan will not only wipe out your credit card debt, it also should improve your credit score for two reasons: you obviously have reduced the amount owed on your cards, which accounts for 30% of your score. The installment loan payments add to your credit mix, which counts for another 10% of your score.

    Debt consolidation loans makes sense, but only if you plan to stop using credit cards while you pay off the new loan you just took out. If not, now you have two problems, instead of one.

    Types of Debt Consolidation Loans

    There are a few forms of debt consolidation loans, any one of which should, at the very least, give you a better interest rate that what credit card companies charge.

    • Debt consolidation loans. Banks make these loans, but their best rates are for customers with high credit scores who want secured loans. That means putting up a car, home or property to secure the loan. Experts advise getting an unsecured loan and credit unions might be the best place to find one with an acceptable interest rate. Credit unions can play with their lending requirements, especially if you’ve been a good customer. Online lenders will make these loans, too, but the rates may be too high for it to make sense.
    • Home equity loans. The fact that you are willing to put your home up as collateral assures that you will get a far lower interest rate on the loan than what you’re paying the card companies. However, if you get behind on payments – and your payment history suggests that is a strong possibility – the lender could foreclose and you would lose your house. Big risk, big reward.
    • Personal loans. This is another bank option, though the money also could come from a family member or friend sympathetic to your situation. Because there is no collateral involved, the banks likely will charge you a high interest rate that won’t make this practical. Family or friends probably would provide better terms and conditions, but if there is no contract spelling those out, things could get very messy.
    • Zero-percent balance transfers. This is a safe option … if you qualify! This offer usually is available to the best customers, meaning people who regularly make on-time payments. You transfer your current card balance to theirs and pay zero percent interest on it, usually for 12-18 months. There also could be balance transfer fees of 3-5% of the amount transferred. And when the introductory zero-percent rate expires, you could be paying 20% or more on whatever balance is left on the card. This is a good option, but only if you are committed to paying down the debt by the time the introductory rate period ends.
    • Borrow against retirement account. This is a terrible idea and absolutely a last resort option. Many 401(k) plans allow participants to withdraw money or borrow 50% of their retirement plans up to $50,000. If you withdraw money, you will have to claim it as part of income taxes, plus pay a withdrawal penalty if you’re not over 59.5 years. If you borrow, you must pay the money back within five years. If you leave the money in the retirement account, it is protected against creditors should they come after you. In other words, there is almost no reason to even consider this option, but it does exist.

    The real question you must answer before choosing one of the above as a solution is whether it makes sense to create a new loan (debt consolidation) in order to satisfy an old loan (credit cards) that you couldn’t pay off to begin with?

    Debt Management as a Debt Consolidation Solution

    Debt management is one of the lesser-known debt consolidation options, but certainly is the easiest one to qualify for and might be the most effective of any methods.

    There is no loan involved so credit scores are not a qualifying factor. You make monthly payments on the debt you owe and the nonprofit credit counseling agencies that administer DMPs, work with the card companies to significantly reduce the interest paid on that debt.

    Interest rates on your credit card debt typically drop to around 8%, sometimes even lower. The counseling agencies also try to eliminate or reduce late payment fees.

    Credit counseling agencies do look at your credit report to make an honest evaluation of your income and expenses. If they see that there is enough income to pay down the debt, they enroll you in a debt management program that usually takes three years to complete.

    If your situation doesn’t fit their parameters, they recommend one of the other debt consolidation options as a solution.

    Debt Settlement as a Solution

    If your credit card debt has grown beyond your ability to repay or if you just want to run from this problem as quickly as possible and don’t care about consequences, debt settlement might be your solution.

    Debt settlement companies offer creditors a percentage of what you owe – usually half – and hope they will accept that amount as full payment. So, for example, if your credit card debt is $20,000, you (or a company you hire to do your bidding) could offer $10,000. If the card company accepts, you send them $10,000 and the debt is settled.

    Who wouldn’t want to do that? Well, card companies for one and other lending institutions aren’t fond of it either. Those are just two of the reasons to look deep at this before choosing it.

    • The debt settlement process typically takes 2-3 years.
    • Debt settlement companies want you to send them any money you would be using for payments, rather than sending it to the creditors. This means that late fees and interest are added to your total every month.
    • Card companies don’t have any obligation to accept settlement offers and many won’t even deal with debt settlement companies.
    • If you use debt settlement, it goes on your credit report for seven years and could hurt your credit score by as much as 100 points.
    • Even if you get the amount owed reduced by 50%, by the time you pay the company’s fees and the late fees, your actual savings would be closer to 20%-25%.

    For some people, none of that matters. They’re happy to be out from under it.

    However, if you plan to get a car or home loan in the next seven years, this could be a problem.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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