Consolidating debt is the process of combining multiple debts from credit cards into one monthly payment. The goal is to lower your interest rate, which can help you save money and pay off your debt faster. There’s plenty to think about as you decide whether consolidation is right for you.
A personal loan is the most straightforward way to handle debt consolidation. You can reach out to a credit union, bank, or online lender for a loan large enough to pay off all your debt. Instead of having multiple credit card payments, you make one fixed payment to the personal loan.
Pros: If you have good credit, you may qualify for a lower rate than your current credit card is charging. Many lenders offer the option for prequalification, so you can shop around without impacting your credit score.
Cons: If you have bad credit the interest rate may be comparable to what you are already paying, or you may not be eligible for a loan. In addition, some lenders charge an origination fee.
Balance Transfer Card
A balance transfer card is used to consolidate multiple credit card balances to one zero-interest credit card. You should plan to pay the balance completely before the 0% interest promotional period is over.
Pros: Many promotions have an introductory period of 0% interest. If you can pay it off during that period, this is a great option! You normally need a good credit score to qualify – 670 or better is recommended.
Cons: The promotional period is typically 12-18 months. If you don’t pay it off in time, the remaining balance will incur interest at the regular rate. In addition, many issuers charge a one-time balance fee of 3% to 5% on the amount transferred. Before you choose a card, calculate to see if you interest savings will cover the cost of the fee.
Home Equity Loan
Home equity loans allow you to borrow against home equity (the difference between how much your home is worth and how much you owe). You can use the cash to pay just about anything: credit card debt, home renovations, emergency expenses, etc.
Pros: The interest rate is often lower than what you’re paying on your credit card.
Cons: Your house is the collateral for the loan. Meaning if you don’t pay you could lose your home. Check with your mortgage lender to find out what to expect with the closing costs to make sure you would be able to afford the new monthly payment.
Generally, I do not recommend taking money from retirement savings. This should only be done as a last resort. Borrowing from an employee sponsored retirement plan, such as a 401(k), gives you access to money to pay debts. The maximum loan amount is 50% of your account or $50,000, whichever is less.
Pros: Often lower interest rates than unsecured loans. There is also no impact on your credit score.
Cons: You have 5 years to repay the money back plus interest. If you can’t repay for any reason, you’ll owe both taxes and a 10% penalty if under 59 ½. Also, if you leave your job you may have to repay your loan in full and within a short time frame.
Instead of withdrawing from retirement savings, a better option could be to reduce your contributions temporarily and use the money to pay down debt. I wouldn’t recommend contributing 10% or more to 401(k) if you still have card balances with interest rates of 20% or more outstanding.
The Bottom Line
Credit card debt consolidation is one way to help pay down your debt. It can be especially beneficial if you can get a lower interest rate. The most important thing is that you are making progress on eliminating debt. The faster you pay it down, the sooner you’ll be able to spend or save your money how you want.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. This information is not intended to be a substitute for specific individualized tax advice