These Are the Best Ways to Consolidate Credit Card Debt
by The Ascent Staff | Nov. 20, 2018
Consolidating credit card debt at a low interest rate enables indebted households to pay down debt faster while paying less interest along the way. From balance-transfer credit cards to personal loans, we'll review some options to find the best way to pay down debt quickly and inexpensively.
Here are three of the best ways to consolidate credit card debt, and the pros and cons of each method.
1. Use a balance-transfer credit card
It's somewhat ironic, but credit cards are one of the best tools for consolidating and eliminating credit card debt. Many cards are designed with indebted cardholders in mind, with offers that include 0% interest rates on balance transfers for up to 21 months.
There are two things to consider when picking a balance-transfer credit card: the duration of the 0% introductory interest period on transferred balances, and the balance-transfer fee a cardholder incurs.
Those who can pay down their debt faster might prioritize a card that has a shorter 0% introductory APR period on balance transfers in exchange for a 0% balance-transfer fee. Others may find it preferable to pay a small balance-transfer fee to unlock a longer 0% introductory interest period.
The three following cards were selected from our list of the best balance-transfer credit cards.
|Chase Slate®||15 billing cycles||No fee on balance transfers within the first 60 days of approval. After that, fees rise to $5 or 5% of amounts transferred, whichever is greater.|
|Citi Simplicity®||21 billing cycles||$5 or 3% of amounts transferred, whichever is greater.|
Data source: card issuers.
For balances that can be paid off in 15 billing cycles (approximately 15 months), Chase Slate® is an obvious winner. Qualifying cardholders can theoretically transfer their balances in the first 60 days of opening an account, pay off their balances during the 15-billing-cycle 0% interest period, and thus pay off the entirety of their credit card debt without incurring a dime of interest or fees.
Citi Simplicity® may be a better choice for cardholders who expect to pay off their balances over a longer period. Notably, the card offers an eye-popping 0% introductory period that spans 21 billing cycles, or approximately 21 months. However, the balance-transfer fee may make it less lucrative for balances that can be paid off faster, given that the 3% fee would add up to $150 on a $5,000 balance transfer. It's inefficient to pay a fee for more time to repay a balance if you don't need it.
The best strategy is to start with cards that lack a balance-transfer fee, even if they have a shorter 0% introductory period. Start with Chase Slate®, for example, pay down balances as much as possible during the intro period, and then move the remaining balance to Citi Simplicity® to finish paying off the remaining balance.
Citi Simplicity® and Chase Slate® require only "good" credit scores, thus making them a better first card for a balance transfer, particularly if your credit score is weighed down by high credit card balances.
2. Consider a personal loan
A personal loan may be a good way to consolidate and pay off credit card debt, but it's an inherently more expensive way to pay down debt than a balance-transfer credit card.
According to data from the Federal Reserve, the average interest rate on a 24-month personal loan was just over 10% per year in February. That's substantially higher than a 0% APR available from several of the best offers.
Of course, lower rates are available for borrowers with excellent credit scores. Several banks show rates of 5% or so for 24- to 36-month personal loans for people with excellent credit. Again, it's a solution, but it's costlier than a balance-transfer card, even for people who have excellent credit. I rank a personal loan as the second best solution, and one worth exploring only if it isn't possible to find a sufficiently sized balance-transfer card to refinance existing balances.
3. Use your home equity
A home-equity loan can be used to consolidate debt at a low interest rate and be repaid over the course of several years (five years all the way up to 15, in some cases). As an added benefit, the interest you pay on the home-equity loan may be tax deductible, thanks to the mortgage interest tax deduction. Qualified borrowers can get rates as low as 4%, which can fall to an effective rate below 3% after tax deductions are taken into consideration.
But before falling for the low interest rates and longer term to repay the loan, consider the downsides. First, the low interest rate may be a mirage. You may have to pay a substantial amount in upfront fees and appraisal costs to secure a low rate on a home-equity loan, erasing some of the interest-rate advantage. In addition, it can take several weeks or months to get through the underwriting process, whereas a personal loan or balance-transfer card can be opened and ready to use in a couple of days, certainly less than a week.
In addition, a home-equity loan is an incredibly risky way to consolidate debt. If you fail to repay a credit card or personal loan, the worst possible outcome is that a judgment in court forces you into bankruptcy. Fail to repay a home loan, and the worst-case scenario is so much worse -- a judgment, bankruptcy, and the loss of your home through foreclosure.
This is a high-stakes way to borrow, and the low rates banks offer reflect how little risk the banks take when they write home-equity loans. Banks like these kinds of loans because they know that if you don't make your payments, they can take your home, sell it at foreclosure auction, and recoup most, if not all, of their money. The borrower will be left with devastated credit and in search of a new place to live.
I bring up home-equity loans solely because they are commonly pitched as a great way to consolidate debt, not because I think they're a good way. The truth is that I see them as one of the worst ways to refinance credit card debt because the risk is enormous, and because they encourage paying off credit card debt slowly over the course of several years, resulting in more money wasted on interest rather than on principal.
The best way to consolidate credit card debt
Given the substantial risk with a home-equity loan, I think it should be thrown out completely as a way to refinance credit card debt. The only advantage that a second mortgage or home-equity loan offers is more time to repay a balance. The disadvantages are the increased risk of foreclosure, potentially high upfront costs (documentation fees and appraisals), and additional time and energy spent going through the underwriting process.
This leaves a personal loan or balance transfer as the best possible option. My view is that 0% balance-transfer cards are the way to go. The ideal balance-transfer strategy is as follows: Open a 0% balance-transfer card with low or no balance-transfer fees, transfer your balances to the card, and then file the physical card away somewhere it's inconvenient to access. Hide the old credit cards, and start using cash or debit to budget every month, so as to avoid the temptation to rack up new balances while paying off old debt.
Those who need more time to repay balances can worry about that later. There is no shortage of 0% APR balance-transfer cards that can be used to roll over balances as the 0% introductory period ends. Plus, if the debt ultimately proves too large to be manageable, cardholders can be relieved that they didn't risk their home to consolidate the balance, or endure higher interest rates on a personal loan.
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