Credit Card Consolidation

10 warnings to heed when you consolidate credit card debt

Credit consolidation can help you get out of debt faster, but only when it’s used correctly.

When traditional monthly payments don’t work, credit card consolidation can be an effective solution to get out of debt fast. You combine credit card debts into a single monthly payment at the lowest interest rate possible. This helps you save money as you pay off debt and it may lower your monthly payments, too. But credit card debt consolidation is not a silver bullet. It won’t work in every financial situation for every consumer. And when it’s used incorrectly, it can make a bad situation with debt even worse.

So, if you’re considering credit consolidation to find debt relief, you need to make sure you’re using it correctly in the right circumstances. If you follow the ten tips below, you’ll give yourself the best opportunity for success.

What is credit card consolidation?

Credit card consolidation refers to any solution that takes multiple credit card balances and combines them into a single monthly payment. The main goal is to reduce or eliminate the interest rate applied to the balance. This makes it faster and easier to pay off credit card debt. Instead of wasting money on interest charges, you can focus your money on paying off principal – that’s the balance your actually owe. In many cases, you can get out of debt faster, even though you pay less each month. Credit card consolidation essentially gives you a more efficient way to eliminate debt.

Options for credit card consolidation

There is more than one way to consolidate credit card debt – in fact, there are three basic solutions. Two are do-it-yourself and involve taking out new financing to pay off your existing credit card balances. The second takes professional help. You set up a repayment plan through a credit counseling agency. But you still owe your original creditors.

  1. A credit card balance transfer consolidates credit card debt by moving your existing balances to a new balance transfer credit card. These cards offer 0% APR introductory rates on balance transfers, giving you a limited time to pay off debt interest-free.
  2. With a debt consolidation loan, you take out an unsecured personal loan at a low interest rate. You use the funds from the loan to pay off your credit card balances. This leaves only the low-interest loan to repay.
  3. A debt management program is basically a professionally-assisted debt consolidation program. You set up a repayment plan you can afford with the help of a certified credit counselor. Then they negotiate with your creditors to reduce or eliminate interest charges.

Identifying the best way to consolidate credit card debt out of these three options depends on your financial situation. That includes how much you owe, your credit score, and how much money you have available for monthly payments.

Warning No.1: Stop making new charges

The biggest mistake people make after consolidating credit card debt is that they don’t stop making new credit card charges. If you’re trying to pay off debt, you need to focus on elimination. New charges just set you farther back from your goal – it’s like two steps forward, one step back.

That’s what happened to Carol. She tried consolidating with a balance transfer credit card, but this zeroed out the balances on her existing accounts. As a result, it was all too easy to start charging again.

Carol from Milwaukee, WI

“I should have left the other credit cards alone once I transferred my balances, but I still needed them to cover basic necessities.”

The right way:  Once you consolidate, you need to set up a household budget. The goal is to cover all your bills and necessary expenses with income. This helps you avoid relying on your credit cards to cover everyday needs.

Warning No. 2: Don’t use DIY solutions if you don’t have good credit

In order for consolidation to be effective, you need to reduce or eliminate interest charges applied to your debt. Otherwise, you don’t generate the cost savings you need for this to be an effective way out of debt. So,  you need at least a good credit score to qualify for do-it-yourself debt consolidation at the right interest rate.

If you don’t have good credit and you try to go DIY, the rate may be too high to provide the benefit you need. Interest charges will eat up every payment you make, making it impossible to eliminate debt quickly or effectively.

The right way: Your goal when consolidating debt should always be to get the interest rate as close as possible to zero. Ideally, you want a rate that’s 5% or less. At most, you need to the rate to be less than 10% in order for your solution to be effective.

Warning No. 3: Don’t convert unsecured debt to secured debt

Most credit cards are unsecured debt. That means that there’s no collateral in place to protect the creditor in case you default. That’s different from secured debt, like a mortgage which uses your home as collateral. In this case, if you default on your mortgage, the lender will take your home and sell it to recoup their losses.

Some people think home equity loans are a good way to consolidate credit card debt. However, this effectively converts unsecured debt into secured. Now, if you fall behind, you can be at risk of foreclosure.

That’s what happened to Carol after her balance transfer solution didn’t work.  A creditor advised that she could take out a second mortgage to pay off her credit cards. That just made her debt problems more stressful:

Carol from Milwaukee, WI

“My mortgage payments went up to $2,000… I could barely make the payments, but only if I started charging my day-to-day needs on credit cards again. And out of that $2,000, I was paying over $1,000 a month in interest on the mortgage.”

Luckily, the third time was the charm as Carol looked for another solution. She found Consolidated Credit and we helped her get back on track. Read Carol’s full story:

The right way: Keep unsecured debt unsecured. There are plenty of ways to consolidate that don’t tap your home’s equity. It’s simply not worth it to use a second mortgage solely for the purpose of paying off your credit cards.

Warning No. 4: Be aware of fees and costs to consolidate

In most cases, you should expect some kind of cost associated with consolidating your debt. Some fees are normal. However, excessive consolidation costs only make it harder to reach zero. So, while you should expect some cost, you should avoid high fees when possible.

For example, let’s say you want to use a credit card balance transfer to consolidate. Almost any balance transfer credit card you choose will have a fee that’s applied for each balance transferred. Some have a $3 fee per transfer, while others are 3% of the balance you move. That’s a big difference. If you transfer $25,000, then the 3% card will increase the cost of debt elimination by $750.

The right way: You should expect some fees, but avoid excessive fees when you consolidate. You don’t want to make your journey out of debt any steeper than it has to be. It’s worth noting that a debt management program has fees, but they get set by state regulation. They also get rolled into your program payments, so you don’t actually incur an extra bill.

Warning No. 5: Don’t be afraid to ask for help

Let’s be honest, most people would prefer to solve their own debt problems without outside help. It’s not easy to let someone into your financial world, especially if things aren’t exactly going well. But using a do-it-yourself solution from a weak financial position is a recipe for disaster.

The right way: If you owe more than $30,000 or a bad credit score, consolidating on your own will be extremely tough. You will usually be better off asking for help.

Alex P. from Miami Lakes, AL

I would like to say Thank you for the outstanding service that you gave me. I started the program just four short years ago and in March I will be debt free. With your help in setting better plans with my creditors I was able to accomplish this. It was hard work, but it was all worth it at the end. The Consolidated credit counselors are the best; they answered all of my question(s) and helped me every step of the way.

Warning No. 6: Don’t lose steam halfway through

When people first consolidate, they’re excited that they finally have a solution to eliminate their debt. So, they’re willing to do whatever it takes to reach zero. However, as time passes, it’s easy to get tired of sticking to a budget and cutting back. As time passes, you slip back into bad spending habits and can start making new charges again.

With debt management program clients, we usually see this drop-off around the six-month mark. Keep in mind that enrollment in a debt management program is completely voluntary. However, if you drop out your creditors are likely to restore your original interest rates and can even reapply penalties.

The right way: First, choose a solution that gets you out of debt as quickly as possible. Anything longer than 60 payments (5 years) is generally too long to keep up with effectively. And always remember, while debt elimination can be tedious, it’s worth it in the end!

Warning No. 7: Never confuse consolidation with debt settlement

Don’t confuse commercials that offer to “settle your debt for pennies on the dollar” with credit card consolidation. Consolidating credit cards – even with a debt management program – is not the same thing as a debt settlement program.

Debt consolidation always pays back everything you borrowed, to help minimize credit damage. By contrast, each debt you settle creates a negative remark on your credit that remains for seven years after discharge.

The right way: Only consider settlement once you’ve exhausted all other options. It should only be used for debts that are already in collections. And if you’re worried about damaging your credit, just don’t do it!

Warning No. 8: Be cautious with new financing

If you consolidate on your own, then you can seek any type of new financing that you need. If you consolidate through a debt management program, you can qualify for loans like a mortgage or auto loan; however, you can’t apply for new credit cards.

In any case, be very careful with any new financing you take out while you repay consolidated credit card debt. Consolidation often makes it easier to qualify, because it fixes your credit utilization ratio and helps build a positive credit history. Those are the two biggest factors used to calculate your credit score.

The right way: Even though you can qualify for a loan, it doesn’t mean that you should apply. Always consider your debt-to-income ratio carefully. If you’re close to your borrowing limit, a new loan could make it tough to keep up with your bills. Ideally, you want your debt-to-income ratio to be 36% or less to make it easy to maintain stability.

Warning No. 9: Check your credit once you eliminate the debt in-full

Once you complete a plan to repay your debt, you should also complete a thorough review of your credit report. Creditor should automatically inform the credit bureaus that your account is paid or current. However, mistakes and errors happen frequently, particularly following a period of financial hardship. That means it’s up to you to make sure your credit report is up to date and that old errors aren’t hanging around.

The right way: Go to annualcreditreport.com to download your credit reports from each credit bureau for free. Then check them for the following errors:

  • Make sure account information has been updated to reflect your zero balances.
  • If you go through a debt management program, make sure the credit history on each account shows that you made your payments on time.
  • Any paid collections accounts should show up as closed; if you negotiated with the collection agency to remove the account in return for payment, make sure it’s gone.
  • All your account statuses should be current.

If you find any mistakes, take steps to dispute them.

Warning No. 10: Learn from your mistakes

The last thing you want after all this work is to end up right back in the same situation. So, figure out how you ended up with so much debt and then take steps to adjust your financial habits. That way, once you get out of debt, you can stay that way.

  • Set up your budget
  • Establish an emergency savings fund to cover unexpected expenses
  • Never spend more than 10% of your income on credit card debt payments.

Of course, even the best-laid plans can get derailed, particularly after a few years. The good news is that if you end up in the same situation, you can always consolidate again.

Step-by-step instructions for credit card debt consolidation

Now that you know what not to do and what you need to avoid when consolidating credit, you can start looking at how to consolidate credit card debt using each method. This will help you decide on the best way to consolidate given your financial situation.

Assessing your financial situation

This table can help you understand how to choose the best consolidation options for your needs.

Consolidation OptionCredit Score NeededRecommended Debt RangeInterest RateMonthly Payments
Balance transferVery good-excellent (FICO 740 or higher)Less than $5,0000% APR introductory rateAs high as possible to pay off balance quickly
Debt consolidation loanGood-excellent (FICO 670 or higher)Less than $25,000Target less than 10% APRMonthly payments may be lower than your total payment now
Debt management programAny score is eligible, including bad$10,000 to $100,000+Negotiated with each creditor; 0-11%, on averageTotal credit card payments reduced by up to 30-50%

 

How to consolidate credit cards with a balance transfer

Balance transfer credit cards allow you to consolidate credit onlineBalance transfers are the best option for credit consolidation when you have excellent credit and a limited amount of debt. Balance transfer cards offer 0% APR for a limited time after you open the account. The higher your score, the longer the 0% APR period.

The goal is to pay off your balance before the 0% APR period ends. Once it does, the regular APR for balance transfers will apply, so your rate will basically be right back up where you started.

  1. Shop for a balance transfer card that offers low fees and the longest 0% APR teaser rate; teaser rates usually apply for 6-18 months, depending on your credit score.
  2. Apply for the best card that you find. Only apply for one card, because filing multiple applications can decrease your credit score.
  3. Once you open the account, begin transferring your balances. You can call customer service or set them up online. You’ll need the account numbers for all balances you wish to transfer.
  4. Be aware that there will be a fee applied for each balance transferred. Fees range from $3 per transfer to 3% of the balance transferred.
  5. With your balances consolidated, quickly pay down your debt. Ideally, you want to pay off the full balance before the teaser rate expires. So, divide your total balance by the number of months you have the teaser rate.

For example, let’s say you owe $3,000 on three accounts. You open a balance transfer card that offers 0% APR for 12 months with a fee of $3 per transfer. You’d pay $9 to transfer the three balances, giving you a total balance of $3,009. To pay that balance off during the introductory period, you’d need to make payments of at least $250.75 per month.

How to consolidate credit card debt with a personal loan

Using a loan to consolidate credit card balances is another DIY option you can use if you have good credit. You take out a loan the lowest interest rate possible and use the funds you receive to pay off your credit cards. This leaves only the loan to repay.

This is often the best way to consolidate credit card debt if you want lower monthly payments. Depending on the term you choose, you can significantly reduce how much you pay each month. But you still get out of debt faster than you would with traditional payments thanks to the low APR.

  1. Shop around for the right debt consolidation loan. You want to aim for low APR, low fees and a term that will give you monthly payments you can afford.
  2. When you find the best loan for your needs, you apply. Only apply for one loan, because applying for multiple loans at once will hurt your credit score.
  3. Choose a term that offers monthly payments you can afford. A longer term means lower monthly payments, but higher total costs. A shorter term will reduce total costs, but it means higher monthly payments.
  4. Once approved, the funds are disbursed to pay off your credit card balances. In some cases, the lender will give you the money to disburse. In others, they’ll pay your creditors directly.
  5. Pay off the loan with fixed payments. If the loan doesn’t have any early repayment penalties, you can also make extra payments. For instance, pay off a big chunk of the debt with your next tax return.

Consolidating credit card debt through a debt management program

Couple listens intently to certified credit counselor as they review their options for debt reliefIf you can’t consolidate credit card debt on your own – either because you have a low credit score or too much debt for a DIY solution – then you need to call in the professionals.

  1. Contact a nonprofit consumer credit counseling for a free debt evaluation. The credit counselor will review your debts, credit, and budget to see if you can use do-it-yourself solutions. If not, as long as you have the ability to make monthly payments, you can usually qualify for a DMP.
  2. Your credit counselor will help you find a payment that works for your budget. Set up and monthly administration fees will be rolled into this payment. Fees are capped at $79 nationwide and set based on state regulations where you live.
  3. Then the credit counseling team calls your creditors to negotiate. They negotiate to reduce or eliminate interest charges and stop penalties that may be getting applied to your debt.
  4. Once all your creditors agree to accept payments through the DMP, your plan starts. You make one payment to the credit counseling agency each month. They distribute the money to your creditors as agreed.
  5. You still owe your original creditors. The credit counseling agency is basically there to be your advocate and help ensure you can stick with the program.

During a debt management program, all credit card accounts you include will be frozen when you enroll. You won’t be able to apply for new accounts during the program. But this can be beneficial because it helps you break any credit dependency that you’ve developed. The credit counseling team also helps you set a budget, so it’s easier to live credit-free.

Important credit card consolidation updates for 2018

Interest rates are on the rise right now. The Federal Reserve has raised the Federal Funds Rate three times this year. And they’re expected to continue raising it in 2019. The Federal Funds Rate is the benchmark rate that lenders use to set interest rates on consumer loans and credit cards. Anytime the Fed has a rate hike, loan and credit card interest rates increase, too.

Higher rates also usually mean shorter teaser rate periods. In 2018, many credit card companies have started to scale back credit card reward programs. This includes the length of the teaser and introductory APR periods. So, while credit users with excellent credit used to be able to find balance transfer cards with 0% APR for 24 months, the best you can get now is 18.

In addition, many creditors are scaling back on credit card limits. They’re concerned that the economy is due for another downturn. So, they want to minimize the risk of customer defaults by reducing the amount of debt they can run up.

All these factors combined mean that DIY credit consolidation solutions are less beneficial. You have shorter 0% APR periods on balance transfers and high interest rates on personal loans. While three years ago, you could qualify for a personal loan with a rate between 5-7%, now most rates are above 10%.

If the economy continues to be strong, then you can expect these trends to continue. So, if you’re thinking of using do-it-yourself credit card consolidation, now is the time to do it. In this case, time is not on your side. But the good news is that these economic changes don’t affect professionally assisted credit consolidation. Since you have an advocate that negotiates interest rates directly with your creditors, economic fluctuations don’t affect these programs.