How to Consolidate Credit Card Debt and Save Money

For many Americans, credit card debt is the biggest financial burden, and the COVID-19 pandemic has made it worse. According to the Federal Reserve, total US household debt will be $17.8 trillion by mid-2024, with $1.14 trillion of that being credit card debt. Individuals are carrying a lot of credit card debt, with delinquencies up big. This is up from 2023, when the average credit card debt per person was $7,932, up from $6,194 in 2022. So many Americans are under a lot of financial pressure with inflation and high interest rates.

Why It's Getting Harder to Pay Off Credit Cards

Compared to other types of debt, Americans struggle most with paying their credit cards on time. As of mid-2024, 9.1% of credit card balances had gone delinquent, which is stressing consumers out. To make matters worse, credit card interest rates have skyrocketed. Rates went from around 16% in 2022 to almost 24% by the end of 2023. This huge increase in interest rates makes it even tougher to pay down existing balances and adds to the debt burden.

With millions of people still drowning in credit card debt, more and more are looking to consolidate credit card debt as a way to get back on track. Here’s how.

What is Credit Card Debt Consolidation?

Credit card debt consolidation is a way to combine multiple credit card balances into one loan or line of credit with one monthly payment, ideally at a lower interest rate. This makes debt repayment easier, reduces interest costs and helps you pay off debt faster without hurting your credit score.

Common Methods of Consolidation

Personal Loans or Debt Consolidation Loans

This is taking out a personal loan with a lower interest rate than your credit cards and using it to pay off your balances. Benefits include fixed interest rates and predictable monthly payments, which can help improve your credit score if you pay on time. However, you need good credit to qualify for the best rates, and origination fees may apply.

Credit Card Balance Transfer

Here, you transfer your existing credit card debt to a new credit card with a 0% introductory APR. The interest-free period can save you money and consolidate multiple payments into one. However, be aware of balance transfer fees (usually 3-5% of the transferred amount) and high interest rates after the introductory period ends.

Home Equity Line of Credit (HELOC)

This allows you to borrow against the equity in your home to pay off credit card debt. While it has lower interest rates than unsecured loans, it puts your home at risk if you default. And closing costs and fees can add up.

401(k) Loans

Borrowing from your retirement savings to pay off debt is another option. It has lower interest rates and no credit checks. However, if not repaid, you may face tax penalties, which will reduce your retirement savings growth.

Debt Management Programs

Working with a non-profit credit counseling agency to create a repayment plan can be helpful. You get professional guidance, and the agency may negotiate lower interest rates for you. However, there are monthly fees for the service and your accounts may be frozen during the repayment period.

Fintech Solutions

In 2024, several fintech companies are offering debt consolidation products that combine the benefits of personal loans with user-friendly mobile apps and AI-driven financial advice. Such products often boast competitive rates but it's also worthwhile to be alert to all the potential pitfalls when reviewing their terms and conditions.

Is Credit Card Debt Consolidation Right for You?

To determine if consolidation is the right move, you need to take a close look at your financial situation. Follow these steps to evaluate your options:

Evaluate Your Debt

List all your credit card balances, interest rates and minimum payments to get a full picture of your debt. This will show you the most expensive debts and potential savings from consolidation.

Check Your Credit Score

Get free credit reports from AnnualCreditReport.com and make sure all info is accurate. Your credit score will affect the interest rates and terms you’ll get from lenders.

Your Financial Situation

Calculate your debt-to-income ratio by dividing your total monthly debt payments by your gross monthly income. Lenders like to see a ratio below 36%; above that and it may affect your ability to get good loan terms.

Research Consolidation Options

Compare interest rates, terms and fees from different lenders, banks, credit unions and online platforms. Look for loans with lower interest rates than your credit cards to get cost savings.

Repayment Plan

Set your goals based on your budget so you can stay on track with payments. Use budgeting tools or apps like Mint or You Need a Budget to manage your money.

Get Professional Help

Talk to a financial advisor or credit counselor for personalized advice. They can help you understand the pros and cons of each consolidation option and recommend what’s best for you.

When Should You Consider Consolidating Your Credit Cards?

You should consolidate your credit cards if:

1. Steady Income and Good Credit: You have a steady income and good credit score (670+)
2. High Interest Rates: Your credit cards have high APRs (20+)
3. Multiple Payments: You have multiple debts to pay.
4. Pay Off Debt Faster: Lower interest rates mean more of your payment goes to the principal balance, and debt repayment happens faster.
5. Being Harassed by Debt Collectors: Consolidation stops collection calls by paying off existing debts and peace of mind.

When Is Consolidation Not Advisable?

While credit card debt consolidation is good for many, it’s not for everyone. Before consolidating, assess your situation. It’s not advisable if:

High Debt-to-Income Ratio

A ratio above 36% may result in denied or unfavorable terms, making consolidation unprofitable. Lenders view high DTI as risky and may offer higher interest rates, negating consolidation benefits. Before consolidating, focus on reducing debt or increasing income.

Small Balance:

If you can pay off your debt in a few months, consolidation may not be worth it due to fees. Calculate the total cost of consolidation (fees) vs your current payment plan. If the difference is small, stick with your current plan and put any extra towards paying off debt faster.

Near Debt Payoff

Fees may outweigh the benefits if you’re near paying off balances. Review your progress and projected payoff date. If you’re 6-12 months from being debt-free, the fees and credit impact of consolidation may not be worth it.

Unaddressed Financial Habits

Without changing your spending habits, you’ll end up accumulating more debt after consolidation. Consolidation fixes the symptom, not the cause of debt. Before consolidating, create a budget, identify unnecessary expenses and develop a plan to live within your means to prevent future debt accumulation.

Low Credit Score

Scores below 580 may not qualify for better interest rates, reducing the benefits of consolidation. With a low score, you may only qualify for high-interest loans or secured options that put your assets at risk. Instead, focus on improving your credit score by making on-time payments and reducing credit utilization before consolidating.

Pros and Cons of Credit Card Debt Consolidation

Credit card debt consolidation has:

Pros

1. Combines multiple debts into one monthly payment.
2. May lower interest rates so you can save money and pay off debt faster.
3. Reduces the chance of missed payments, which can improve your credit score over time.
4. It lowers your credit utilization ratio, which can boost your credit score.
5. This may open up more financial opportunities in the future because of better credit.

Cons

While credit card debt consolidation is good, it also has:

1. May have upfront costs and fees (e.g., origination fees, balance transfer fees, closing costs) that can add to your debt and offset some of the savings from lower interest rates.
2. Clearing credit card balances may tempt you to spend again and get into a worse financial situation if not managed properly.
3. With secured loans, assets like your home are used as collateral, so if you default, you’re increasing your risk, especially if your income is unstable.

Impact of Debt Consolidation on Credit Score

Consolidating your credit card debt can have both positive and negative effects.

Positive:

• Paying off credit cards reduces your utilization rate, which helps your score.
• Making consistent payments with the new loan helps your credit.

Negative:

• Applying for new credit gets hard inquiries, which temporarily lowers your score.
• If you don’t have good financial habits, you’ll end up with new debt.

Tip: Keep old credit card accounts open but unused to keep your utilization ratio low and credit history long, both of which help your score.

Alternative Strategies for Those with Bad Credit

If you have bad credit, traditional consolidation may not be an option. Try these:

1. Secured Personal Loans: Use collateral (like a car or savings account) to get lower interest rates. Be careful. If you default, you’ll lose your assets. Make sure you can afford the payments before you choose this option.
2. Peer-to-peer lending: LendingClub or Prosper may have options for those with bad credit. Compare rates and terms carefully; they vary widely based on your credit score.
3. Debt Management Plans: Work with non-profit credit counseling agencies to create a payment plan, get structured support and possibly lower interest rates. These plans often include financial education to help you not get into debt again.
4. Credit-Builder Loans: These small loans, offered by credit unions, are to help you build credit. The loan amount is held in a savings account while you make payments. Your credit score will improve over time.
5. Debt Snowball or Avalanche: These DIY methods don’t require good credit. The snowball method pays off the smallest debts first and the debt avalanche method pays off the highest-interest debts first.

Address the root causes of debt

Long-term financial health means addressing the behaviors that led to debt accumulation:

Tackle the root causes of debt in the long term requires that what caused the debt be tackled:

Create a Realistic Budget:

• Track all income and expenses for at least a month.
• Pay for essentials, savings, and paying off debts.
• One would also need a budgeting application or spreadsheet.
• Review and adjust your budget regularly as necessary.

Build an emergency fund

• Start with a tiny sum, say $500-$1000, to handle minor emergencies.
• Accumulate savings to cover 3-6 months of living costs end
• Balancing your emergency fund into an easily accessible but separate account.

Improve Financial Literacy:

• Invest in courses or workshops on money management.
• Read great financial books and blog on the best financial blogs.
• Attend free seminars presented by local banks or community centers.

Seek professional consultation:

• Consider consulting a financial advisor for personalized strategies.
• Seek advice on how to handle debt from non-profit credit counseling agencies.
• Consult a tax professional to ensure you're maximizing your deductions and credits.

Conclusion

Credit card debt consolidation can be a good tool for regaining control of your finances but you need to choose the right approach and be disciplined. By knowing your options, assessing your situation and addressing the behaviors that got you into debt, you can get on the path to debt freedom.

References:

1. Federal Reserve. (2024). Consumer Credit - G.19. Retrieved from https://www.federalreserve.gov/releases/g19/current/
2. XYZ Financial Insights. (2024). Annual Consumer Debt Survey. Retrieved from https://www.xyzfinancialinsights.com/reports/annual-consumer-debt-survey-2024
3. National Foundation for Credit Counseling (NFCC). (2024). Credit Card Debt and Consolidation Trends Report. Retrieved from https://www.nfcc.org/resources/reports/credit-card-debt-consolidation-trends-2024/
4. Better Business Bureau (BBB). (2024). Consumer Guide to Credit Counseling and Debt Consolidation. Retrieved from https://www.bbb.org/article/consumer-guides/credit-counseling-debt-consolidation-2024
5. Smith, J. (2024). Personal interview with financial advisor.
6. Consumer Financial Protection Bureau. (2024). State of Consumer Credit Report. Retrieved from https://www.consumerfinance.gov/data-research/research-reports/state-of-consumer-credit-2024/
7. American Bankers Association. (2024). Credit Card Market Report. Retrieved from https://www.aba.com/news-research/research-analysis/credit-card-market-report-2024
8. Johnson, L. (2024). The Impact of AI on Debt Management. Journal of Financial Technology, 15(2), 78-92. https://doi.org/10.1000/jft.2024.15.2.78