Vehicles for debt consolidation
When you’re consolidating card balances, it pays to move slowly and methodically.
While you’re at it, weigh the alternatives and ask a lot of questions. Otherwise that fresh start you’re hoping for, with your credit card balances on 1 card, could just make a bad situation worse.
Here are the 5 best options for debt consolidation of credit cards, along with some advantages and drawbacks of each.
Check out our calculator to see how much debt consolidation would cost you.
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Using 1 credit card as the repository for all your card debt is fighting fire with fire. So it’s smart to be cautious if this is your plan for debt consolidation.
What you need is a card with a limit high enough to accommodate your balances and an annual percentage rate (APR) of interest low enough to make consolidation worthwhile.
Advantages: It’s quicker and easier to get a card or credit-line increase than a bank loan, says Bruce McClary, spokesman for the National Foundation for Credit Counseling.
And a credit card is unsecured, so you’re not risking assets.
Drawbacks: Before applying, ask about balance-transfer limits and fees, says Celeste Collins, executive director of OnTrack Financial Education & Counseling.
Also: You won’t learn the APR or credit limit until after you’re approved — if you’re approved.
And, whether you request a credit-line increase or apply for a brand-new credit card, the issuer will pull your credit history, which can lower your score, McClary says.
Last, but definitely not least: Once you’ve transferred debts to 1 card, stop yourself from running up a balance again.
Home equity loan or HELOC
Home equity loans and home equity lines of credit, or HELOCs, amount to the same thing: another mortgage on your home.
Advantages: You’ll often get lower interest rates and — if you have some equity — larger amounts than with personal loans or credit cards, McClary says. And interest is typically tax deductible.
Home equity loans have longer repayment periods, which can mean lower monthly payments but also more interest over the life of the loan, he says.
Drawbacks: It doesn’t get more risky as a method of debt consolidation. You’re offering your house as collateral for what’s now unsecured credit-card debt, McClary says. So you’re trading the discomfort of card bills for the possibility of losing your home.
It also often takes longer to get a 2nd mortgage — a few weeks to a few months, he says.
Home equity loans can come with variable interest rates, McClary says. So today’s affordable payment could be tomorrow’s debt debacle.
Also called a “signature loan,” a personal loan is an unsecured loan. Unlike a credit card, it features fixed, equal monthly payments, says McClary, of the National Foundation for Credit Counseling.
Loan amounts vary with credit score and history, and personal loans typically top out around $10,000, he says.
While banks and credit unions make signature loans, subprime lenders are also very active in this market, McClary says. So it’s important to shop carefully and understand rates, terms and fees, he says.
Advantages: It’s unsecured, meaning there are no assets at risk.
Drawbacks: A large, prime-rate loan requires good credit, says McClary. And rates are typically higher than for home-equity loans.
Savings or retirement accounts
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The wisdom of this one depends on your debt load, savings, where you’re keeping that savings and what’s going on in your life. Some points to consider:
Savings account: Borrow from savings and it isn’t lost interest you worry about. It’s about competing needs for that money, says OnTrack Financial’s Collins. Don’t leave yourself without emergency funds just to consolidate debt.
401(k): If your job is stable, you’re fine. But if you quit or get fired, the entire 401(k) loan becomes due immediately, Collins says.
Roth individual retirement account: There’s no penalty for borrowing what you’ve deposited in your Roth IRA. But you will want to be sure that consolidating debt outweighs the lost principal and compound interest in retirement.
You contract with a nonprofit credit counseling agency to negotiate with creditors and draft a pay-off plan.
You close all card accounts and make 1 monthly payment to the agency, which pays the creditors. But, you still receive all billing statements.
Advantages: You’ll get lower interest rates (not balances) and an end to over-limit and late fees, McClary says. Also, agencies will work for low- or no cost, if you’re struggling.
Drawbacks: You can’t reach for credit cards in a pinch. And closing accounts will lower your credit score, he says.
But a soon-to-be-released Ohio State University study reveals that after 18 months on a debt-management plan, consumers’ average credit scores increased from 588 to 608, McClary says.
To create a debt-management plan, stick with nonprofit agencies affiliated with the NFCC or the Financial Counseling Association of America. And, make sure your debt counselor is Council on Accreditation-certified, Collins says.