We’ve been talking a lot about debt consolidation around here lately…and for good reason. Done right, debt consolidation can be just the tool you need to mobilize the best possible debt payoff plan. This is especially true with high interest rate credit cards that make gaining any progress very difficult if you don’t find a way to lower your rate. Problem is, the whole “done right” concept can be pretty tricky.
I’ve been on both sides of the debt consolidation coin. I’ve done it wrong and ended up staying in credit card debt for years longer than I needed to be. Then I did it right and became credit card debt free months ahead of schedule. All happened by using the same tool two different ways: debt consolidation without a plan and debt consolidation with a plan. I’ll let you guess which one worked better…
If you’re battling impossibly high interest rates on your credit cards and think debt consolidation could be the tool for you, read on to find out the best methods to use to consolidate your credit cards. But remember, debt consolidation is not a debt cure-all. Without a payoff plan in place along with consolidation, you could end up in an endless cycle of debt. So tread carefully, choose the method that will work best for your specific situation, and remember to get a payoff plan in place immediately.
How to Consolidate Credit Card Debt
First of all, let’s talk about all the different types of credit card consolidation there are. The good news is there are a lot of options. The bad news is there is no one “best” option. When reviewing these methods, consider your strengths, your weaknesses, and your priorities to choose the one that will work best for you.
The Shiny Object: Balance Transfer Credit Cards
My Experience: I have a love/hate relationship with balance transfer credit cards. My first go with a balance transfer credit card went terribly and only enabled me to get further into debt. My second go with a balance transfer credit card enabled me to become debt free faster than I expected.
Note the problem: me. The product remained the same – but the timing, my financial education, and my readiness to pay off debt differed. That’s why this option was bad for me the first time and good for me the second – I was a different person both times.
How it works: With a balance transfer credit card, you’re essentially applying for a new credit card that will pay off one or more of your current credit cards. The reason this is beneficial is because they often come with a low or 0% interest rate for six months to one year. That’s a lot of time to make some serious progress paying down your principal balance! (Not to mention how good it feels to turn multiple monthly payments into one monthly payment.)
How it can go wrong: A balance transfer credit card is still a credit card. That means the suggested minimum payment won’t be even close to enough to get you paid off before that promotional rate expires – and it means you could still use the card for purchases (often at a higher interest rate). And it doesn’t automatically close your old cards, which means you could also use those again. See how this can get a little messy?
How to make it work: The balance transfer credit card is unquestionably the cheapest way to pay off debt as it’s one of the few options that comes with a 0% interest rate. But it will only help you pay off debt if you:
- Immediately suspend all use of your old cards and never use the balance transfer card for purchases
- Calculate how much you’ll need to pay each month to pay it off by the time the promotional rate expires – because the minimum payment won’t get you there
- If you still have a balance when the rate goes up, get a new balance transfer credit card or debt consolidation loan to battle against the inevitably high interest rate you’ll have on that same card and make sure you pay it all off this time around
If you have a solid payoff plan in place as well as a second plan of action in case that doesn’t work out, then this could be the right tool for you. But if you have any fear that you won’t be able to sustain a self-driven plan, you might want to consider other options.
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The Slow and Steady Wins the Race Option: Unsecured Loans
My Experience: When I first tried to consolidate my credit card debt, I wanted to get an unsecured loan. I was attracted to the fixed interest rate and fixed payoff period – what felt like a guarantee that I would pay my debt off if I just followed the steps the loan would require me to follow.
But I didn’t do it because the interest rates come at a higher rate than a balance transfer. Originally, I regretted this decision. A self-driven plan such as the balance transfer wasn’t right for me the first time around. But then the second time around I knew what I was doing and didn’t need the guidance of an unsecured loan.
How it works: It could be possible to obtain an unsecured loan from your bank for debt consolidation – but the most common way to do it now is through peer to peer lenders such as Lending Club and Prosper. Basically you apply for a new loan that will pay off your current credit cards and then you’re given a specific payoff period for the loan. Oftentimes they’ll even deduct the payments out of your checking account each month.
How it can go wrong: Since unsecured loans don’t come with 0% interest rates, they will cost more money than most balance transfer credit cards. But that’s not so much the product “going wrong” as much as it is a conscious decision you take on as a consumer. This strategy can go wrong for similar reasons as the balance transfer – no one is closing your old credit card so there’s no stopping you from using it if you want to. This is fine if you can pay the balance off every month but not if you carry a balance from month to month, leading to more debt.
How to make it work: The unsecured loan doesn’t require you to calculate anything to pay off your debt – all you have to do is make sure you’re making your required monthly payments and your consolidated debt will be paid off by the end of your term. However, if you can, it’s a great time to create a new budget that allows you to save up for an emergency fund. That way, if you ever want or need to use your credit card, you may already have the funds socked away in your emergency fund. The emergency fund is a great debt prevention tool!
The Collateral Bet: Home Equity Loans
My Experience: I’ve never been a homeowner so I don’t have any experience with this type of loan. However, for a homeowner with a good amount of equity, it could be a chance to consolidate debt at rates much lower than they’re paying on their credit cards.
How it works: You apply for a loan to consolidate your credit card debt, using your home as collateral. The rates may be higher than a balance transfer and potentially could be lower than an unsecured loan.
How it can go wrong: This is a biggie. Putting your home down as collateral on anything puts you at risk of losing your home if you default. And default could mean as little as one month late, depending on your lender. Do not consider this option unless you feel prepared to take that risk.
How to make it work: Never, ever make a late payment on a home equity loan. As long as you pay on time, every time, then your home should be safe and you’ll pay down your debt. And, like all other debt consolidation methods, your old credit card will remain open so make sure you have a plan in place to avoid using it – or to pay off the balance by the end of the month if you do use it.
How to Make Sure Your Payoff Plan Sticks
You may have noticed a theme in talking about these credit card debt consolidation methods: they all require that you remain cognizant of the need to avoid future debt. While each method can be a very useful debt payoff tool, none of them will get you out of debt unless you continue to avoid debt moving forward. So how can you do that?
- Make a budget if you don’t already have one
- Maintain a stringent debt payoff plan
- Start preparing for the future by building your savings
With this strategy in place, then these tools can help you achieve your dream of debt freedom. But at the end of the day, it all comes down to you. Are you ready? Let’s get rid of this debt beast once and for all!
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Image Credit: Thomas Hawk