What to Know About Consolidating Credit Card Debt
The more credit cards you have, the more difficult it may become to juggle the monthly payments. You must remember to schedule at least the minimum payment for each card with an outstanding balance. If a payment slips through the cracks, you’ll be hit with a late fee and possibly a penalty APR.
Beyond the nuisance of scheduling multiple credit card payments each month, you also have to spread your repayment money across all the cards, which may require you to make minimum payments. This is a problem because you basically are paying interest without reducing your principal amounts significantly.
Card consolidation solves the two problems:
- By replacing multiple monthly payments with a single one, scheduling is much easier and you’re less likely to forget a payment.
- The minimum payment on a single card is much less than the total of the minimum payments on multiple cards, meaning more of your payment goes toward reducing principal.
Let’s review the best ways to consolidate your credit card balances.
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You can siphon funds from your savings and/or investment accounts to repay your balances. That’s fine if you’ve got plenty of extra money lying around, but if that was the case, you might not have built up multiple credit card balances. Do not raid your retirement accounts to repay your credit cards because you’ll trigger taxes (and possibly penalties), and you’ll lose the tax-deferred growth of the money you withdraw. Plus, you’ll reduce your retirement nest egg.
A balance transfer allows you to move all your credit card balances to one card, usually a new card with a balance transfer promotion. Here’s how to do it:
- Add up your outstanding balances to get the consolidation amount.
- Obtain a new credit card featuring a 0% introductory APR for balance transfers. You want a card that will give you a credit limit at least as large as the consolidation amount plus fees. You’d also like to pick a card with a long promotional period – 15 to 18 months. That’s how long you’ll have to complete paying off the consolidation amount without triggering any interest charges.
- After receiving the new card, transfer the balances from your existing cards to the new card. Most card issuer websites offer an online procedure to accomplish this. Alternatively, you can call the customer service number and arrange the transfers over the phone. Make note of the amount you’ll be charged in one-time transfer fees, usually at least 3% of each balance.
- Continue to pay at least the minimum payments on your existing cards until you receive confirmation that their entire balances have been transferred out.
- Divide the total consolidation amount by the number of months in the 0% APR introductory period. That’s the minimum amount to pay each month, although you can certainly payoff off the consolidated balance.
- During the repayment period, do not use your credit cards. Instead, use your debit card to pay for your purchases, since this won’t increase your debt. If you continue to use your credit cards during repayment, you could end up in worse debt than when you started.
As you reduce your total balance, your credit utilization ratio (i.e., credit used / credit available) will fall, a positive for your credit score. It’s best to get your CUR below 20%, and to avoid score-destroying values above 30%.
Do not close the card accounts you no longer plan to use, as this will reduce your average account age, which can hurt your credit score.
Consolidate Credit Card Debt With A Personal Loan
You can borrow money to pay off your credit card balances. You simply deposit the loan proceeds into your checking account and then direct payments to each of your credit cards via check or electronic funds transfer. You want to make sure that the interest rate on the loan is at least lower than the weighted average interest rate of your card balances. Best of all is a loan interest rate below that of card with the lowest APR.
There are several types of loans you can consider:
- Personal loan: This is a good source because it doesn’t require collateral. However, it’s hard to get a personal loan if you have bad credit. If you can’t qualify for a personal loan from a bank or credit union, try using an online provider of personal loans, such as lender-matching services and peer-to-peer lenders.
- Secured loan: This is a loan backed by property, such as cash, your home, your car, your stash of gold coins, and so forth. For example, if you own your home and have built up equity, you can get a home equity loan or home equity line of credit (and the interest is tax-deductible).
- 401k loan: If you have a 401k, you may be able to borrow from it. You’ll have to repay the loan within five years, with interest, or it will be treated as a withdrawal.
- Family and friends: You might be able to negotiate a good deal but be careful! If you don’t meet your repayment responsibilities, you may ruin your relationship with the lender.
Credit card consolidation, when done correctly, can be an important step in improving your credit score and your financial security.
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Eric Bank is a business and personal finance writer who has been featured in Credible, Wisebread, CardRates, Zacks and many other outlets. He holds an M.B.A. from New York University and an M.S. in Finance from DePaul