Choose the Right way for You to Consolidate Credit Card Debt
There are many paths to solve credit card debt problems. The best way to consolidate credit card debt for you, may not work for someone else. The right way, or the best way to consolidate credit card debt, is subjective and depends on your financial situation and goals. Do you want to save money, lower your payments, get collectors off your back, or just make it easier to pay your credit card bills? Do you have equity in your house, a large income, savings, and extra money at the end of the month?
The major ways to consolidate credit card debt are as follows:
- Balance Transfer and Payment Maximization
- Home Equity Loan or cash-out refinance
- Unsecured personal loan
Other debt relief solutions include credit counseling, debt settlement, and chapter 13 bankruptcy. If you cannot take a new loan to consolidate debt and are having trouble making the payments then check out these other debt relief options. Depending on the depth of your problem and willingness to deal with stress, one of these programs may be best for you.
Match Your Financial Situation with Your Goals
A key component in finding the best solution is to do a thorough financial check-up. Create and maintain a budget to best utilize your financial resources. Control your costs, limit your credit card debt, and build up emergency funds, savings and retirement accounts. In order to find the best way to consolidate credit card debt, concentrate on these questions:
- Cash flow: Do you barely make ends meet, or do you have plenty of cash reserves at the end of the month?
- Home Equity: Do you have a lot of equity in your house or you are underwater?
- Credit Score: Do you have a strong credit score or you are struggling to keep your score at a poor level?
Your goals will vary based on your financial situation. Choose between lowering your payments or paying off your debt quicker or a combination of the two.
Find the right direction!
The best way to consolidate credit card debt is the one that fits you. No matter which path you choose, take the following two steps:
- Avoid minimum payments: In general, monthly minimum payments on a credit card are equivalent to about 2-3% of your balance. Your monthly payment declines as your balance declines, until a minimum fixed amount kicks in. This is the worst way to pay off your credit card debt as it makes the time to pay off very long and expensive.
- Save money: Save on your monthly expenses. Use Bills.com saving machine to give you an idea of how cutting expenses, like a cup of coffee a day, can save you lots of money.
Here are the different paths that you can take:
Balance transfer: If you have good credit, then you can consider trading in your old card for a new lower interest rate card. Be careful not to take a new card that has a great introductory offer and then hits you with high interest rates.
Constant (or accelerated) payment: Instead of decreasing your payments, you continue to make the minimum payments on all your cards, except for one that you make larger payments, never dropping your monthly payment. Either pay off the highest interest rate card first, or the lowest balance. You will finish your payments much quicker, but it requires discipline to maintain the same high payment.
Cash out refinance: A cash-out mortgage loan requires equity in your home and a good credit score. This option allows you the cheapest interest rates and the most flexibility in the time to pay off your debt. Today’s low interest rates make it attractive to refinance mortgages, and if you have enough equity then you can do the cash out refinance.
HELOC: You will need sufficient equity in your home that can be a problem in today's market if you have a large first mortgage. HELOC's carry higher interest rates and a shorter period than a cash-out mortgage loan refinance. However, closing costs are lower, because you take out a smaller loan.
Unsecured personal loan: Major and credit unions offer unsecured loans. In general, you need good credit to take out a personal loan and the payback period is limited to about 5 years. The rates can go up quite significantly, making it unattractive to consolidate credit card debt with a personal loan. If you have bad credit then be very careful, because personal loans for bad credit carry high interest rates. Very aggressive collection agencies service these types of loans.
Cost analysis of the different programs:
Before you decide on the best way to consolidate credit card debt, understand the implications of each solution. Look through the example below to get an idea of the monthly payment, total interest cost, and term of each solution. The example below assumes:
- Credit Card Balances: $25,000
- Interest rate: 18% (weighted average for all cards)
- Minimum payment: 2.5%
The table below shows the total interest payment and time to pay off the debt under each alternative. Clearly, the better the credit score and the more equity you have in your house, the more flexibility you have. You can take out loans for different periods, and the interest rates will change accordingly.
|Minimum Payments||Cash-out Mortgage Refinance||HELOC||Unsecured Personal Loan||Constant Payment on Credit Card|
|Monthly Payment||Starts at $650 and decreases. $20 minimum.||$158||$236||$541||$550|
|Term (to pay off)||405 months||240 months||180 months||60 months||77 months|
|Total Interest Payments||$36,731||$12,959||$17,846||$7,464||$17,303|
Which Route to Take to Consolidate Credit Card Debt
Two general conclusions:
- The worst way to pay off credit card debt is to restrict yourself to minimum payments.
- Do not consolidate credit card debt and then run up new debt.
The best way to deal with your debt depends on your financial situation:
- If you have equity in your house and good credit, then do a cash-out refinance or HELOC. Shop around for the best mortgage deal.
- If you have good credit, but no equity in your house, then take an unsecured personal loan and/or a credit card balance transfer. Shop around for the best deal and concentrate on banks and credit unions.
- If you have bad credit then your options are very limited. Work on improving your credit score. Maximize your credit payments, getting rid of high interest payments. Try to consolidate your balances on your low interest cards. If you can afford the minimum payments, then look into credit counseling and a debt management program.
- If you have bad credit and have difficulties making your payments then consider a debt settlement program.
It takes hard work and persistence, but you can find the right path to consolidate your credit card debts and be debt free.