A crucial step between building an emergency fund and investing for the long term is to pay down any high-interest credit card debt. Here we’ll explore how exactly to consolidate and refinance credit card debt to save big on interest charges.
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Introduction – Why Consolidate Credit Card Debt?
So why consolidate credit card debt? First, high-interest credit card debt can feel extremely burdensome and overwhelming. Secondly, if you’re carrying credit card balances, interest charges add up much faster than you probably realize. This means you’re paying unnecessarily high interest charges, and it takes longer to pay down that balance. Ultimately, in the larger context of investing, this means it takes longer to start saving for retirement.
Let’s look at how debt consolidation works.
How Debt Consolidation Works
In consolidating credit card debt, we’re talking about taking balances from multiple high-interest credit cards and combining them into one new loan at an interest rate lower than the average of the cards. Again, this lowers total interest costs and shortens the payoff period. The new single monthly payment also simplifies things and reduces headache versus having multiple payments to make from cards with different repayment terms.
For a simplistic, hypothetical example, you may currently have 3 credit cards with respective interest rates of 19%, 20%, and 21%, with balances of $1,000 each. This means you have a total debt of $3,000 at an average 20% interest rate. The new debt consolidation loan would be a single loan for $3,000 at an interest rate that is hopefully lower than 20%. The 3 credit cards are immediately paid off and you now have a new single payment to make each month instead of 3.
How To Consolidate Credit Card Debt
There are various tools and methods for consolidating credit card debt. The consolidation tools available to you depend largely on your credit score and amount of total debt. You can get an idea of where your current credit score stands and check for errors on your credit report for free and without hurting your credit with Credit Karma.
There’s usually a debt consolidation tool for everyone, even those with low credit scores. Let’s explore what those specific tools are.
Balance Transfer Cards
Balance transfer cards are arguably the most popular way to consolidate credit card debt and are the most widely available. As the name implies, you’re simply transferring the balances from multiple credit cards to a single new card with a lower interest rate. Balance transfer cards are credit cards specifically designed for this purpose. Technically, this specific type of consolidation using the same product is known as refinancing. In this context, the terms refinance and consolidation are generally used interchangeably.
Usually, balance transfer cards have introductory 0% APR promotions for a certain time period, usually 12-18 months. For example, you may get 0% APR on the entire balance for 12 months, meaning you pay zero interest if you pay off the balance in that 12 month time period. After that, the remaining balance will accrue interest at the card’s regular rate that will likely be comparable to that of your existing credit cards.
Most balance transfer cards charge a one-time fee for the transfer itself, usually around 3% of the balance transferred. From our previous example, transferring a balance of $3,000 would result in a one-time fee of $90.
Favorable terms on a balance transfer card typically require a very good to excellent credit score. Also keep in mind that you usually cannot transfer balances between accounts from the same card issuer, meaning if your current credit cards are from Chase and Bank of America, your new balance transfer card probably shouldn’t be from one of those companies.
Similarly, a personal loan provides you with a lump sum to immediately pay off all the credit cards at once, after which you’re only paying down the balance of one account instead of multiple. There’s even a specific type of personal loan referred to as a debt consolidation loan.
Personal loans typically have a repayment term of 3-5 years with a fixed interest rate. As such, a personal loan is likely more appropriate than a balance transfer card for a large amount of debt that you won’t be able to pay off within 12-18 months (the introductory 0% APR promotional period for most balance transfer cards).
Most lenders in this space will directly pay your current creditors so you don’t have to do it yourself. This also eliminates the temptation to use any part of the loan for something other than paying down your current high-interest credit card debt.
Personal loans typically have a lower interest rate than the regular rate on a balance transfer card, but they also tend to be available for those with lower credit scores for whom a balance transfer card may not be available. Your interest rate and acceptance will depend on your credit score. Remember that you can avoid interest altogether with a balance transfer card by paying off the balance completely during the introductory promotional period. If you know you’re not going to be able to do that, a personal loan may be a better choice for your specific situation. The interest rate on a personal loan does not change for the life of the loan, providing a predictable repayment schedule.
Personal loans typically have more flexible repayment options to choose from, and you’ll also likely see a boost in your credit score from diversifying your types of credit and decreasing your credit utilization due to your new, higher total credit limit.
Modern, online loan providers streamline the process and oftentimes even have lower interest rates than local credit unions, because they don’t have the overhead of physical locations, and they’re only in the business of providing loans. You can shop around while applying for prequalification without hurting your credit score; this typically isn’t an option with traditional banks and credit unions.
Look for the best interest rate with favorable repayment terms, but also watch out for any potential one-time fees – called an origination fee – charged by the lender that will increase the total cost of the loan. This is similar to the balance transfer fee for balance transfer cards; it is usually a percentage of the amount borrowed. A personal loan with a higher interest rate and zero fees may end up having a lower total cost than a loan with a lower interest rate but high origination fee. A loan’s origination fee will vary based on factors like amount borrowed, loan term length, credit score, reason for borrowing, etc.
Arguably most importantly, choose a loan with a monthly payment that you know you can afford. Thankfully, most personal loans do not have early repayment penalties, but you will likely be penalized if you miss a payment.
PersonalLoans.com is a lender network through which you can quickly and easily shop for a personal loan that suits your needs. Upstart and Upgrade are other great options I’ve used in the past; they’re online personal loan providers – with quick and easy applications – that are specifically designed to pay down credit card debt.
If you happen to specifically have bad credit and need a loan under $10,000, BadCreditLoans.com may be a good option for you, but will likely carry less favorable terms than the above 2 options, so check those first.
Riskier Options – Home Equity and Margin
If you happen to already own a home, you can also obviously use a HELOC (home equity line of credit) or a home equity loan. Just be aware of the risks of using your home as collateral. Since the loan in these cases is secured by your home, there’s a very real possibility of losing it if you fail to make payments.
A home equity loan or HELOC is also usually going to require a new home appraisal and closing costs, which makes the process lengthier, more cumbersome, and potentially more costly in terms of fees.
A similar option is a margin loan on your taxable brokerage account, wherein your investments are the collateral.
Consolidating or refinancing credit card debt is never a bad idea. Doing so can save you time, money, and effort by combining your debt into one single, predictable payment. Explore whichever option above provides the most favorable terms to fit your personal situation based on interest rate and repayment schedule. These include balance transfer cards and personal debt consolidation loans. Try to avoid taking on a home equity loan or margin loan if you can.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.