Debt consolidation: What's the best approach for you?

Debt consolidation is a great way to reduce your debt and pay it off faster. It can often give you a single, lower monthly payment that’s easier to manage and pay on time. Those on-time payments can even improve your credit over time. If you’re having difficulty remembering due dates, consolidating can streamline and simplify the management of your finances.

Additionally, with a lower rate more of your payment goes toward the principal balance (the original sum of money you borrowed) helping you get out of debt faster. Imagine you owe $15,000 across three credit card accounts, each with annual percentage rates (APR) between 20% and 25%. By qualifying for a balance transfer to a new credit card or personal loan with a 12% interest rate, you could potentially save hundreds of dollars or more in interest payments throughout the duration of the loan.

There are a few different options to consider when consolidating your debt—credit cards, personal loans and home equity loans.  Your unique situation will determine which one is best for you.

Credit Cards

If you have available credit on one of your existing cards with a low rate or can qualify for a new low-interest credit card, you have the option to transfer your balances from other credit cards and loans over to that card.

Pros:

• By transferring to another credit card with a lower interest rate, your payment won’t change, but you can pay off the debt faster because more of your payment is going to the principal balance instead of interest.
• As you pay down your credit card, you’ll have more credit available if you need it in an emergency.
• If you have multiple credit cards, you can consolidate into one easy payment instead of worrying about multiple payments and due dates.
• Many financial institutions have a special balance transfer rate that is significantly lower than the standard interest rate. At Credit Human, the rate stays the same until you pay off the balance you transferred. You can see our current balance transfer rates for our credit card offerings here.
• When transferring debt, you might be able to get more favorable terms beyond the lower interest rate. For example, our Rewards Plus Mastercard has 2% cashback on every purchase. Note: we recommend waiting until your debt is paid down to a manageable level before charging more to a credit card.

Cons:

• Credit cards generally have a higher rate than loans.
• Some credit card companies charge a balance transfer fee between 3% - 5%.
• Additional purchases often will not have the same low interest rate as the balance you transferred.
• Closing your existing credit cards once you transfer those balances can negatively impact your credit, at least in the short term. That may still be a worthwhile trade-off to keep you from being tempted to charge up those credit cards again.

Personal Loans

Applying for a personal loan is another option to enable you to pay other higher-interest debts. One of the main reasons someone might choose personal loans for debt consolidation is to lower their interest rates and avoid potentially taking on more credit card debt. As long as the interest rate is lower, this could also be a good option for paying off student loans.

Pros:

• Personal loans generally have lower rates than credit cards.
• They offer a single, fixed payment schedule for a predetermined length of time.
• Taking out a personal loan increases your credit mix, which could boost your credit score. It shows lenders your responsible with money by carrying different types of credit.

Cons:

• If you have a high debt-to-income ratio or a lower credit score you may not qualify for a personal loan, at least not without a co-signer.
• A personal loan does not leave you with an available line of credit to use for emergencies once it is paid off.
• Personal loan due dates are inflexible throughout the life of the loan and can damage your credit score if you miss any payments. This can become a problem if you experience instability in your future income.

Line of Credit

A line of credit (LOC) is like a hybrid between credit cards and personal loans that allows you to borrow, repay and borrow again up to a set amount. You can write checks or use a debit card for access and borrowers can use only what they need and pay interest only on that amount.

Pros:

• Best used when you are unsure of the total amount of money needed. You can use as much or as little as you need to pay off your other debts and use it for other opportunities such as home improvements.
• An unsecured LOC does not require collateral like a home equity loan and there are no fees for cash advances like a credit card.
• Payments can be readjusted based on your spending plan.

Cons:

• Payments are not fixed and usually require minimum monthly payments based on a percentage of the total amount borrowed.
• Most financial institutions have variable rates on their LOC. However, it is important to note that at Credit Human we keep our LOC rates fixed—which is a plus.

Home Equity Loan

If you already have a home loan with available equity, you can apply for a home equity loan. This allows you to use the equity in your home to pay off your outstanding debt.

Pros:

• Home equity loans generally have the lowest rate option compared to credit cards and personal loans.
• Loan terms can go up to 15 years, making the payment more manageable.

Cons:

• You can only qualify for a loan if you have enough equity in your home. In Texas for example, borrowers can't owe more than 80 percent of the market value of their home on their mortgage and home equity loans combined.
• Qualifying for a home equity loan can be more difficult depending on the current state of your credit.
• If you miss payments, you run the risk of losing your home.

We’re here to help

No matter which option you choose, this is a great opportunity to commit to reducing high-interest debt going forward. That could mean closing credit cards with high interest rates and adjusting your spending habits. By spending more intentionally and saving consistently, you can build a financial cushion to handle emergencies and stay on track with your goals.

Stop by one of our Financial Health Centers or make an appointment with a specialist so we can discuss your unique situation and explore the options best suited to your needs.

Before you go: Learn how to get ahead of your debt and tips to communicate with creditors.

Other Resources

Get Ahead of Your Debt

Tips to Communicate with Creditors