Compare Options for Credit Card Debt Consolidation

What happens when you consolidate?

Three key things happen when you consolidate credit card debt:

1. You get one monthly payment: Instead of juggling multiple bills throughout the month with different due dates, you have just one payment. It’s easier to manage your bill payments and avoid late payments that can lead to extra fees.
2. You minimize interest: This means that more of each payment you make goes to pay off the debt instead of accrued monthly interest charges.
3. You can get out of debt faster: Since the interest is minimized, this means you can get out of debt faster even if you’re still making the same payment each month. In fact, you may pay less each month and still get out of debt faster.

A practical example: Understanding debt consolidation with $10,000

Let’s illustrate the impact of debt consolidation using a common scenario: a $10,000 credit card balance with an 18% APR. The standard minimum payment, at 3% of the balance, would start at $300.

Minimum payments

If you only make minimum payments, it will take 226 payments to pay off the balance in full. That’s 18 years and 10 months before you’d be debt-free. During that time, you’d pay $9,597.78 in interest charges. In other words, you almost double the cost with added interest charges.

Fixed payments

Let’s say you make fixed monthly payments of $300 instead of just paying the minimum. It would still take 47 payments to pay off the balance— that’s 3 years and 11 months. The total interest charges would be much lower, but at 18% APR you’d still pay $3,967.21 in interest charges.

Debt consolidation

Now let’s say that you consolidate with a 36-month loan at 10% APR. The debt would be paid off in 36 payments or exactly three years. The monthly payments would be $322.67. The total interest charges would be just $1,616.19.

If you got a 48-month loan at 10% APR, the monthly payments would be just $253.63 and the total interest charges would still only be $2,174.04. So, you’d pay off the debt in roughly the same amount of time as fixed payments, but with much lower monthly and total costs.

How debt consolidation works

Debt consolidation is more of a process than a single solution. In fact, there are a range of financial products that allow you to consolidate debt. These include:

• Balance transfer credit cards
• Personal debt consolidation loans
• Debt management programs
• Home equity loans
• Home equity lines of credit (HELOCs)
• Cash-out mortgage refiancing
• 401k loans
• Life insurance policy loans

Some of these products are better than others. For instance, in most cases you want to avoid borrowing against your 401(k) retirement plan or life insurance. Borrowing against your 401(k) can drain income you’ll need later in life and could significantly delay your retirement. Your life insurance policy is there to protect your family in case something happens to you.

Borrowing against home equity can also be risky for homeowners, as it can increase your risk of foreclosure. It’s usually not advisable to borrow against your equity solely for the purpose of paying off credit cards and other unsecured debts. You essentially convent unsecured debt to secured.

However, if you’re thinking about borrowing against your equity for other purposes, such as home renovations, you may consider using some of the funds to consolidate debt. If so, always consult with a HUD-certified housing counselor so you can understand the risks and weigh the benefits.

For the purpose of this guide, we’ll be focusing on the three most popular and unsecured ways to consolidate debt—balance transfers, consolidation loans, and debt management programs. Here is a detailed explanation of how each of these solutions works:

Option 1: Balance transfer

This is a do-it-yourself option that requires a good to excellent credit score in order to be successful. Here’s how it works:

1. You qualify for a balance transfer credit card based on your credit score.
2. These cards offer low or 0% APR on balance transfers for a limited time after you open the account—usually between 12-18 months.
3. The better your credit, the longer the reduced or 0% APR introductory period.
4. Once the account is open, you transfer your existing balances. You can either call the customer service line to provide account numbers and balances over the phone or you can enter them online.
5. You usually must pay a balance transfer fee on each balance you move; fees range from $5-$10 or 3%-5% of the balance moved.
6. With your debt consolidated, you pay it off in the largest chunks possible.
7. The goal is to eliminate your debt in-full during the interest-free period.

Learn more about balance transfers »

Option 2: Personal loan for debt consolidation

This is another do-it-yourself option for consolidation. You need good to excellent credit in order to use this solution effectively. Here’s how this options works:

1. You apply for an unsecured personal loan through your preferred lender.
2. They evaluate your credit to determine eligibility and set your interest rate.
   1. You choose a term that offers monthly payments you can afford
   2. A shorter term means higher monthly payments, but lower total costs
3. Longer terms mean lower monthly payments, but higher total costs because there are more months to apply interest charges.
4. Once approved, the money gets disbursed to your creditors to pay off your balances. In some cases, the lender will deposit the money into your bank account, and you use the funds to pay off your balances. In others, the lender may disburse the money directly to your creditors.
5. This leaves only the loan to repay.

See if a consolidation loan is right for you »

Option 3: Debt management program

This is a professionally assisted way to consolidate debt. It’s the only solution that works regardless of your credit score. So, this is the only way to consolidate if you have bad credit. Here’s an overview of how a DMP works:

1. You request a free debt and budget evaluation from a certified credit counselor.
2. They evaluate your debt, credit and budget to see which solutions will work in your situation.
3. If the DIY solutions listed above aren’t feasible, they check to see if you’re eligible for a debt management program.
4. As long as you have the means to make a reduced monthly credit card payment, you typically qualify.
5. If you’re eligible, you and the counselor determine a consolidated monthly payment that you can afford.
6. Then, they call each of your creditors to negotiate. The goals are:
   1. Get your creditors to agree to have their debt included in the program
   2. Work with your creditors to reduce or eliminate interest charges and stop future penalties
7. Once all your creditors sign off, the program starts.
8. You make one payment to the credit counseling agency each month, which they distribute amongst your creditors every month.

Do you need help to consolidate your debt? »

This is one example of how a debt management plan helped a client consolidate credit card debt effectively:

What types of debt can you consolidate?

The types of debt that qualify for debt consolidation will depend on what financial product you use to consolidate. It may also depend on the specific credit card or loan that you use. For example, some balance transfer credit cards will only allow you to transfer credit card balances, while others may allow you to transfer a wide range of loans.

Always check terms carefully before you consolidate so you know which accounts you can include.

In general, you can consolidate most unsecured debt:

• General-purpose credit cards
• Store credit cards
• Charge cards
• In-store credit lines
• Unsecured personal loans
• Third-party collection accounts
• Back child support and alimony*
• IRS and state back taxes*

*These debts cannot be included in a debt management program.

Can you consolidate student loans?

Student loans can be iffy. You cannot include student loans in a debt management program. But even some debt consolidation loans and balance transfer cards won’t take student loans. That’s because student loan debt is unique and is even treated differently during bankruptcy.

However there are other options for consolidating your student loans. If your loans are federal, you can explore the Direct Consolidation Loan program through the U.S. Department of Education, which allows you to combine multiple federal loans into a single loan with one servicer, potentially simplifying your repayment. If you have private loans, they can be  refinanced through private lenders for potentially lower rates.

Can you consolidate secured debts?

Secured debts generally cannot be consolidated with unsecured debt. However, some debt consolidation loans and balance transfers have now started to allow auto loan consolidation. Mortgages and mortgage products like home equity loans and HELOCs cannot be consolidated.

Choosing the best option for debt consolidation

“Choosing the right option to consolidate debt is highly dependent on your financial situation,” explains Gary Herman, President of Consolidated Credit. “What works for a friend, family member, or neighbor may not necessarily work in your situation. So, you need to evaluate your financial situation carefully to choose the solution that fits your needs, credit, and budget.”

This chart compares the three debt consolidation solutions outlined above based on four key financial factors:

The impact of debt consolidation on your monthly payments depends on your specific situation.

• Balance transfers often involve increased monthly payments because you want to pay off the debt in full before the interest-free period ends.
• Debt consolidation loan payments may be higher or lower depending on the loan term (length of the loan) that you choose.
  • A longer term will usually result in lower monthly payments but higher total interest charges.
  • A shorter term will increase the monthly payments, but reduce the total cost.
• Debt management program payments are based on your budget. In many cases the monthly payments are lower.

How does debt consolidation affect your credit?

When done correctly, debt consolidation generally has a positive effect on your credit. No matter which option you use to consolidate, it will not generate any negative notations in your credit report.

The effect of debt consolidation on your credit score and how it gets reported on your credit report varies based on which solution you use.

How balance transfers affect your credit

When you transfer your existing balances to a balance transfer credit card, you will notice the following changes in your credit report:

• The application for the credit card will be noted as a “hard credit inquiry” on your credit report for two years
• The balances on your existing cards will drop to zero
• The new credit card account will be reported on your credit report
• All payments on the consolidated debt will be noted on the new account.

The impact on your credit score on your credit score can vary, but it will affect your score in the following ways:

• The new credit application can decrease your score by a few points initially, but the impact will diminish within six months
• The new account may also decrease your “credit age” which measures the average length of time you’ve had your accounts open.
• The new credit limit will decrease your “credit utilization ratio” which measures how much debt you have relative to your total available credit limit. This will be positive for your score.
• All payments made on time will improve your payment history, which is the biggest factor used to calculate your credit score

How debt consolidation loans affect your credit

When you consolidate with a personal loan, you will notice the following changes in your credit report:

1. The credit application will be noted as a hard credit inquiry for two years.
2. The balances on your credit cards will be reduced to zero.
3. The new loan will show up on your credit report.
4. All loan payments will be noted in the payment history for that account.

Here is how a debt consolidation loan may affect your credit score:

• The hard credit inquiry may decrease your score by a few points, but this will diminish over the next six months.
• The new loan account may decrease your “credit age” which measures the average age of your accounts.
• Your credit utilization ratio will be decreased significantly. While loans don’t increase your credit limit, your current balances on all the cards you consolidate will drop to zero.
• Payments made on the loan will improve your payment history.

How a debt management program affects your credit

When you consolidate with a debt management program, this is what you will see on your credit report:

1. The program will not generate a hard credit inquiry. While a credit counselor will check your credit before you enroll in a debt management program, this is a “soft credit inquiry.”
2. The program will not create a new account on your credit, because it is not a loan or credit line.
3. Your credit card balances will not be immediately paid off.
4. Instead, all the payments you make on a debt management program will be noted in the payment history of each account you include in the program.
5. The balances will gradually decrease as you pay them off.

Here is how a debt management program may impact your credit score:

• The soft credit inquiry will not affect your score at all.
• The payments you make on time on the program will improve your payment history.
• Gradually, your credit utilization ratio will decrease as your balances decrease.
• However, since each credit card gets closed when it’s paid off, this will decrease your total available credit limit, which also impacts your utilization ratio.
• What’s more, closing accounts will also decrease your credit age, which can also damage your credit.

The credit score impact of a debt consolidation program is generally positive or neutral overall. However, if your credit score is extremely high before you enroll, you could see your score decrease.

If you have a high credit score, you may want to consider do-it-yourself debt consolidation first.

Debt consolidation in today’s economy

The present economy offers both good and bad points for those looking to combine their debts. Low interest rates have been favorable, but there’s uncertainty about how long that will last. Possible changes in interest rates and ongoing inflation add to this unpredictability. This makes planning your finances, including debt consolidation, more challenging. Banks are also being more careful about lending. Getting good deals might be harder, especially if your credit is not strong or you owe a lot. Banks may offer smaller loans or shorter interest-free periods to protect themselves.  

“It’s a catch 22 for many Americans,” explains Gary Herman, President of Consolidated Credit. “Debt consolidation would help them pay off their debt, simplify their bill payment calendar, and even reduce their monthly payments to improve their budget. However, it’s harder to qualify for balance transfer cards and debt consolidation loans. Only people with the best credit scores and moderate amounts of debt can qualify.  What’s more, lenders are limiting loan amounts and interest-free periods on balance transfers. So there’s a challenge there as well.”

Even so, combining debts can still be helpful. Those with strong credit can still use loans or balance transfers to lower their total interest costs. If your credit is not perfect, credit counseling and debt management programs can be extremely beneficial.

In short, doing well with debt consolidation today requires careful thought about your money, good research of your choices, and knowing the good and bad points of each method, especially with so much change and uncertainty in today’s economy.