Consolidating Credit Card Debt in 5 Easy Steps
If you are drowning in credit card debt, you may be able to save money and pay your debts off quickly if you choose to consolidate credit card debt. By evaluating your situation as well as your options, you can determine whether this makes sense for you. Here are the steps to take to consolidate your credit card debt and improve your financial situation. But first, we must identify the problem.
The first step to debt freedom: Identify the root cause
Once you’ve decided to make paying off your credit card debt quickly a priority, it’s time to start creating a plan. But financial experts warn against immediately refinancing or increasing your monthly payment.
“You first have to understand the root cause of the debt,” says Ryan McPherson, Certified Financial Planner, a fee-only financial planner and the founder of Intelligent Worth in Atlanta, Ga. “Was it a single big expense? Were you underinsured? Have you been overspending month after month?”
This understanding, he says, is crucial to avoiding a slide back into debt.
“One of the worst things you can do,” McPherson says, “is consolidated your debt and then run your credit cards right back up again.”
There are two main reasons why people end up in credit card debt.
1. Chronic overspending
If you’re spending more than you make each month, you will wind up in debt sooner or later. And on top of that, continuing to spend like that will make it impossible to get out of credit card debt, no matter how you choose to go about repayment.
Getting an accurate understanding of how much money is coming in each month and where it’s going, and then taking steps to get that spending under control, is essential when finding the best way to pay off credit card debt.
But if you want to take a more proactive approach, considering trying a more robust tool like You Need a Budget. It costs $50 per year, but it offers a more structured program that allows you to take control of your money going forward, rather than just looking back at where it’s gone.
Either way, getting your spending under control is a necessary first step to quickly paying off credit card debt.
2. Not having an adequate emergency fund
Everyone has big expenses that they didn’t expect from time to time, and an emergency fund is often the difference between handling those expenses with savings or having to resort to a credit card.
An emergency fund is a money you keep in a savings account, waiting for the unexpected. Most financial experts recommend having three to six months’ worth of expenses set aside, which should be enough to handle both minor and major emergencies.
That kind of savings can be difficult to build though, and it’s often either because you don’t have enough income beyond your necessary expenses to save significantly or because you don’t have enough control over your spending.
If it’s an income issue, you might consider negotiating a raise or taking on a side hustle so that you have more money coming in.
If it’s a spending issue, it comes back to taking control, reducing expenses, and finding a way to build up at least some savings that prevents you from having to resort back to credit cards when the next unexpected expense comes up.
Gretchen Caldwell, a fee-only financial planner and the president of Pure Planning in San Francisco, suggests building at least a $2,000 emergency fund, even if you have high-interest credit card debt. That money will help prevent you sliding back into credit card debt when the next unexpected expense comes up, allowing you to make real, consistent progress.
5 Steps to consolidate your credit card debt
Step 1. Assess Your Debt Load
First, you must know just how much credit card debt you actually have. Gather all of your credit card statements and add up exactly how much you owe. Find two sums: your total debt load and your total estimated monthly payments. Once you know your total loan balance and your total monthly payments use our debt consolidation calculator to determine if consolidating credit card debt can save you money. This will help you find the best method for credit card debt consolidation.
Step 2. Know Your Monthly Income
Look at your take-home pay, but also subtract your monthly expenses. This includes your mortgage, food, utilities, car payment, cable bill, and more. Chances are you vary how much you are currently paying toward your credit card debt each month depending on how much extra money you have when your payments are due. Knowing how much of your income is already obligated toward bills can help you to figure out how much is available for credit card consolidation. If you are struggling to pay off a substantial amount of debt while also currently living on a lower income level, click here.
— Learn how to save more with budgeting tips and techniques here.
Step 3. Choose a loan product to consolidate your credit cards
There really is no good reason to continue paying high credit card interest rates. Using your home or a personal loan, you can avoid high-interest rates through credit card consolidation. Below are the options for this:
Home Equity Loans
home equity loan (HEL) can be a great option when consolidating credit card debt. You borrow against your home equity to get a loan at a fixed rate. Although the interest rate on a HEL is usually higher than that of a first mortgage, it is also usually far less than a credit card. Instead of making payments to each of your credit card companies each month, you make just one payment on the home equity loan. Suppose you were paying 18 percent interest on your credit cards. With a HEL, you may get a rate of 6 percent. That is a third less in interest, and it really makes a difference in your monthly payment after you consolidate credit card debt. It is important to remember that if you take out a HEL, your home equity will be tied up and will not be available to you if you sell your home. Also, the HEL must be repaid upon sale of the house.
A personal loan can be used to consolidate your credit cards if you do not own a home or choose not to use your home equity. Instead, you can obtain a personal loan from a lender at a lower interest rate than a credit card, although it will probably be a higher rate than a loan that uses your home as collateral.
Another option if you want to consolidate credit cards is cash-out refinancing. This means refinancing your mortgage to one with a higher principle so that you can get some of your home equity back as cash for you to use. You can use it to consolidate credit cards if you choose. It is possible that your monthly mortgage payment may not even go up if you use cash-out refinancing. Even if it does, your monthly debt obligation will still be less since you consolidated your credit cards into your mortgage. You will definitely pay significantly less in interest. However, the loan is secured by your home, so remember that you can lose your home if you default.
Step 4. Know the Risks
If you choose to use your home equity for credit card consolidation, be sure you understand the risks. The benefit is that you get better interest rates because the loan is secured to your home, but using your home as collateral is also a risk. If you default on your loan, you run the risk of losing your house. Borrowing against your home should always be carefully considered before jumping in. Understanding the risks of a possible decision can help you determine which come with too much risk for you and your situation.
Step 5. Control Your Spending
The final step to credit card consolidation is to use financial restraint. Once you have consolidated your credit card debt, it is vital to keep your spending in check so that you don’t fall into the trap of running up even more high-interest credit card debt.
5 Reasons to consolidate your credit card debt
Now that we’ve gotten into the tips and tricks for how to get out of credit card debt, it’s worth asking why paying off your credit card debt is even a worthwhile goal.
Here are five good reasons.
1. You’ll improve your credit score
A good credit score means better terms when applying for a mortgage, auto loan, and other types of credit, and it can even help you get a job, rent an apartment, and secure lower insurance premiums.
And while there are multiple factors that go into your credit score, there are two that affect it the most:
- Payment history – Consistent, on-time payments lead to a better score.
- Credit utilization rate – This is the percentage of credit available to you that you are actually using. If you have a $5,000 balance on a credit card with a $10,000 limit, that’s a 50 percent utilization rate. Lower rates are better, with rates under 20 percent preferable.
Nearly two-thirds (65%) of your credit score is determined by those two factors, and paying off credit card debt quickly will positively impact both of them.
First, you’ll have to make on-time payments in order to make consistent progress and avoid late fees and extra interest charges.
Second, paying off credit card debt decreases the amount of credit you are actually using, which leads to a lower utilization rate.
Quite simply, paying off your credit card debt quickly is one of the best ways to increase your credit score.
2. You’ll save money in the long run
The quicker you pay off your credit card debt, the less money you’ll end up spending on interest.
Beware of minimum payments
The easiest way to avoid all of those late fees and collection tactics is to make at least the minimum payment on each of your cards on time every single month. Doing so will keep your account in good standing.
But making only the minimum payment can also cost you money and keep you in debt for a very long time.
Let’s say you owe $10,000 on a card with a 14% interest rate and a $217 minimum payment. Here’s how extra payments will affect both the interest paid and the time it takes you to get out of credit card debt:
|Paying the Minimum vs. Paying Extra|
|Minimum payment||Additional $50||Additional $100|
|Months To Pay Off||68||50||40|
|Total Interest Paid||$4,432||$3,222||$2,543|
To put it another way, every extra dollar you put toward your credit card debt is equivalent to earning an immediate and guaranteed investment return equal to your interest rate. Given that long-term returns from the stock market are generally expected to be 7 to 8 percent, and that those returns are not guaranteed, a double-digit return on your credit card debt is pretty attractive.
3. Less debt means more cash on hand
Once you’re debt-free, the money you were previously putting toward credit cards every month is available for all your other goals.
FInancial goals like building an emergency fund and saving for retirement become a lot more achievable. Life goals like traveling the world, changing careers, or starting a business become a lot more realistic.
Credit card debt makes it hard to achieve the things that really matter to you. Paying it off opens up those things to you.
4. You’ll be under much less stress
Not to be understated, you’ll sleep better at night once you’ve paid off your debt and no longer have it hanging over you every minute of the day.
The elimination of that daily anxiety can make a huge difference in the quality of your life, from your enjoyment of everyday activities to the quality of your relationships, to your ability to try new things and take positive risks.
5. You’ll create good financial habits
Paying off credit card debt will require you to create good new financial habits, and those habits won’t disappear once you’re debt-free. They will stick with you, making it even easier for you to achieve your other financial goals once your debt is behind you.
Does it make sense to consolidate your credit card debt?
In order to determine if consolidating credit card debt makes sense for your situation, ask yourself the following questions:
- Is the interest that you are paying on your credit cards significantly more than you would pay on a home equity loan, cash-out refinancing, or personal loan?
- Do you have more credit card debt than you are able to pay off in a few months?
- Do you have enough home equity available to consolidate credit card debt but still have some left over in case you need to sell your home?
- Can you restrain your spending so that you do not fall further into debt after consolidating credit cards?
If you answered yes to all or most of these questions, then consolidating may be a smart choice for you. Investigate your options and work out a plan to get out of credit card debt and stay out of it in the future.