Having a lot of credit cards with high balances is challenging. Too often, we wind up making minimum payments which just seems to drive those balances higher. One of the options many consumers turn to is debt consolidation. While this process may be helpful, it’s important to understand the pros and cons of using this method of getting your credit card debt out of control.
Methods Matter with Debt Consolidation
People can take various approaches to consolidating their debt. Some of the most common methods include:
1.) Home equity loans
2.) Moving all balances to a new card
3.) Taking an unsecured loan (often called an installment or personal loan)
4.) Borrowing from a retirement account
5.) Borrowing from friends and family
Each of these methods has good and bad points and before you decide whether or not to take any path to debt consolidation, it’s a good idea to know the upside and downside.
Home Equity Loans for Debt Consolidation
One of the best things about home equity loans is they typically offer a low interest rate. This is because you are securing the loan with your house. However, if you fail to pay off the loan, you could be facing numerous problems, including losing your home to foreclosure.
If you are considering a home equity loan to consolidate your credit card debt, make sure you know ahead of time how much your monthly payments will be and start getting rid of some of your cards. Avoid running your balances back up or you will be further in debt and will not gain any financial ground from consolidating. One reason home equity loans work so well is that you improve your credit rating in two ways: first, you have more available credit and your debt usage ratio will shrink. Second, making regular payments on the equity loan shows you are responsible with your debt.
Move Balances to a New/Single Credit Card
If you have not started falling behind on your credit card balances, you could benefit by transferring all your credit card balances to a single card. This can be complicated; keep in mind, many credit card companies offer low introductory rates on balance transfers. The problem is, these rates often expire very quickly, typically within six months.
Initially, it may be a good idea to reach out to one of your existing creditors and ask if they have a suitable card that could help you. Let them know your intention is to transfer all of your credit card balances to a single card. This option can be very good if you plan to pay off the balance in six months or less; or if the company would agree to lengthen the term of low/no interest. This is also a great boon to your credit; be cautious however, once you transfer all of your balances, use your now paid off cards as little as possible.
Debt Consolidation with Unsecured Loans
If your credit has not taken a significant hit because of late payments, you may qualify for a loan from a bank or credit union. There are important things to watch for including loan term and interest rate. If your consolidated interest rate is not low enough to justify the loan, you could wind up paying more than if you continued to make regular payments on your cards as they are today.
Unsecured loans (sometimes referred to as installment or personal loans) put no lien on your home which is a positive; however, if you fail to make payments, your credit rating will be reduced and you could have a harder time qualifying for another loan at a later time. As with all other types of consolidation, you must be wary of using your credit cards after they’ve been paid off; otherwise you’ll be right back in the same spot, having trouble making monthly payments.
Borrowing from Retirement Accounts
In most cases, unless your tax advisor recommends otherwise, this would be the least likely option to meet your needs. Let’s talk about how this works: if you have an IRA account, you can borrow money for 60 days without facing a penalty. The upside of this is fairly simple; you simply need to repay yourself if you’ve liquidated a portion of your IRA.
The downside is easy to calculate; if you liquidate enough money from your IRA and you can’t put it back in 60 days, you’ll have to pay a tax penalty. If the tax penalty is relatively low, then your best bet is to determine how much it will save you in interest and determine if it’s worth the gamble. Another pitfall to this is also fairly simple to understand; you’re dipping into money you may need for the future.
Debtors who have 401(k) or pension plans through their employer may be able to borrow money against their plan. These loans are usually offered with very low interest rates, are not contingent on your credit and are paid back through payroll withdrawals in many cases. The biggest danger of these loans is that if you lose your job, you’ll have to pay it back in full or the amount will be liquidated from your plan resulting in an additional tax burden.
Borrow from Friends or Family or Seek a Personal Loan
Borrowing from your family and friends is always a tricky option; you must approach this professionally when you’re asking for money. Offer friends/family members a specific “return” on the money they’re loaning you (just like the interest you’d pay a bank) and make sure your agreement with them is in writing. This not only helps protect them, it also ensures they know you’re serious about repayment.
If you’re unable to make a payment or if your agreement is to have the full amount of the loan from a friend or family member paid back by a specific date and you’re unable to make that deadline, don’t avoid having a discussion with them beforehand. There are few things that will destroy relationships faster than money; always have a plan and keep your loan agreement.
If friends or family can’t help, you may be able to secure a personal loan by working with BetterLoanChoice.com. For fifteen years the team at BetterLoanChoice has been helping people with good and bad credit get approved for personal loans. We do not make loans, and we do not make credit decisions. Instead, we attempt to connect you with participating lenders who offer loans. We have spent time analyzing the lending marketplace and have learned which lenders can help you and who wastes your time.
In conclusion, your options are numerous when considering debt consolidation. Make sure that whatever decision you make, that you avoid using your credit cards excessively once they’re paid down. Failing to do this could mean you wind up in the same position in a few months.
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