Reducing your interest rate is just one of three big reasons why credit card debt consolidation can be a smart move.
Owing a lot of money on credit cards can be costly and a major hassle, especially if you have lots of different cards you owe on and multiple payments to make. Paying down debt should be a top goal, and one option to consider to take control of your debt is to consolidate it.
Credit card debt consolidation can involve using a balance transfer credit card, transferring your outstanding balance from one or more credit cards onto a new card with a low promotional interest rate. You could also take out a personal loan, home equity loan, or even a 401(k) loan to consolidate your credit card debt -- although the last two options are risky.
If you're on the fence about debt consolidation or not sure if consolidating your credit card debt is the right choice, consider these key reasons why consolidation can be a smart financial move.
1. You can reduce your interest rate
Credit card interest rates typically top 15% APR and rates are sometimes much higher, especially if your credit isn't perfect or if you've ever been late in paying. If your credit card has a 15% annual rate and interest compounds daily, you'd pay around $12.58 per month in interest for each $1,000 you owe.
This may not seem like much, but if you maintain a $5,000 balance on your card over the course of the year, you'd pay more than $800 in interest by year's end.
Balance transfer credit cards, personal loans, home equity loans, and 401(k)s can all reduce the interest you pay -- sometimes substantially. If you opt for a balance transfer credit card offering a 0% introductory interest rate, you'd pay no interest at all until the promotional rate expired. Every dollar paid toward debt would go to reducing principal.
A personal loan could also reduce your interest rates. Say you had two credit cards and owed $2,500 at 17% APR and $3,000 at 22% APR and you were making a $100 monthly payment on each. It'd take you 3 years and 9 months to repay both cards and you'd pay $2,003 in interest.
But, if you consolidated debt using a 36-month loan at 9.24%, your monthly payment could be reduced to $175.51. Total interest paid would be $818 and you'd repay the debts in 3 years. You'd save $1,184.51 in interest and reduce your payment time by 9 months.
2. You can lower your monthly payment
Credit card companies require you to make minimum payments. If you have multiple cards you owe a lot on, these minimum payments can add up to a substantial sum. If you consolidate credit card debt, you'll have just one new loan to pay. Because you can shop around among different lenders and different kinds of consolidation loans, you can often opt for a new loan that has a lower monthly payment than the combined payments on your existing debt.
It's important to focus on why your payment is being lowered with your new loan. Ideally, your total monthly cost will be reduced because your interest rate is lower. But, if you simply stretch out the repayment timeline, your monthly payments will be lower but you could pay more total interest since you're paying interest over a longer timeline.
The best way to maximize savings is to consolidate to a new loan with a lower rate but keep making higher monthly payments so you can get your debt paid down faster. But, if you're struggling with payments that are too high for you, consolidation to reduce your monthly obligations could be a solution.
3. You can simplify the debt repayment process
Having multiple lenders to pay is a major hassle. You have to set up automated payments, transfer money, or send checks to everyone you owe. Your cards may all have multiple due dates, and you can't afford to be late on any payments lest you get hit with a late fee and damage your credit score.
If keeping track of debt repayment has started to seem like a full-time job, consolidation will make life much simpler. By moving all your existing debt onto one new card or getting one new loan to repay all you owe, you'll only have one creditor to deal with. Sending in your single monthly payment will be quick and easy and you'll spend less time managing your money.
Is consolidation right for you?
These are all major advantages to consolidation. There are downsides to consider, however, including the possibility of getting deeper into debt if you consolidate and charge up your credit cards again.
Consolidation is best used as part of a comprehensive approach to repay all that you owe and get a handle on your finances once and for all. If you're ready, start looking into consolidation options today to find the right approach for you.
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