Credit & Debt Consolidation 101

Debt consolidation for credit cards and other types of debt can decrease your monthly payments and improve your credit score. Rather than paying multiple bills, you can make just one payment. Having one due date instead of managing multiple ones decreases the likelihood that you’ll incur a late fee from missing a payment.

The best debt consolidation method for you will be the one that works with your type and amount of debt as well as your credit score. For instance, your financial history will greatly impact whether you qualify for an unsecured or a secured loan. 

Factors That Lead to Credit Card Debt

Debt occurs when you spend more than you earn. Credit cards make it easy to do this because limits, especially the combination of multiple cards, can exceed what you earn in a month or even a year. 

You can incur a lot of credit card debt when you are young and inexperienced at managing finances. It can be surprising how fast credit card bills can rack up. It can feel as if you are not spending any funds since you are using a card rather than cash and not actually seeing the money leave your ownership. 

Some bad credit card habits include:

  • Having too many credit cards

  • Only paying the minimum payment amount

  • Making charges just for the cashback or other perks

However, massive credit card debt can occur at any age, for instance, following an automotive or medical emergency. Similarly, you may use your credit cards to handle sudden home repairs or pay for groceries and other living expenses when there is a lull in your income.  

Credit card debt can cause your credit score to drop. You may miss payments if you have too many cards, which can mean a negative mark on your payment history. A large amount of debt can also hurt your score since it impacts your utilization ratio (the amount of debt you have compared to the credit you have available).

Why You Should Consider Debt Consolidation

While a credit card can be a quick fix for many situations, debt consolidation can be a better long-term solution. Refinancing your existing debt into a single low-interest loan can save you hundreds to thousands of dollars in interest charges. It can also save you a bit of money each month with lower payment requirements. 

Credit cards and loans charge interest differently. For one, credit cards have higher rates typically between 16 and 25 percent, whereas loans are lower ranging between 4 and 14 percent. Credit cards also compound interest, which means lenders charge you interest on interest, so it will take longer to pay the balance. 

If you have a 20 percent interest rate on $10,000 of collective credit card debt, then you will need to pay at least $167 a month to cover the interest. Without adding more charges, it would take you more than 22 years worth of $300 payments to pay off the debt. In the end, you would have paid an additional $12,110 in interest. 

However, a loan with an interest rate of 14 percent would only take only six years of $206 payments to pay off $10,000. Also, you would have only paid $4,832 in interest. By using a consolidation loan, you can reduce your monthly payments as well as save you money long term. 

How to Consolidate Debt

Some of the best debt consolidation methods include the following:

  1. Work with a credit counseling and debt consolidation professional. Not only can a counselor work with your creditors and set up a payment plan, but they also give you advice to avoid debt in the future. This may include teaching you how to budget, manage money and save for the future.

  2. See if you qualify for a personal debt consolidation loan. If you suddenly find yourself in massive debt due to an emergency, then transferring the debt into a loan with a lower interest rate could help you pay it off faster as well as decrease what you will ultimately pay.

  3. Transfer the balance to an interest-free credit card. Similar to a debt consolidation loan, transferring your existing debt to a credit card with a promotional interest rate of zero allows you to pay the debt without incurring interest. However, you should only choose this option if you think you will pay off the debt within the 12, 18 or however many months the promotion lasts. 

  4. Get a secured loan. A debt consolidation loan is an unsecured loan, which means that you do not need collateral. If you have poor credit, then you may need to obtain a secured loan by using property as security. For instance, some lenders may lend you cash equity in your car or home. If you fail to make payments, however, then the lender can take your property.