Credit Tips with Tiff: Debt Consolidation Options

Dear Tiff,

I’m basically drowning in debt. I’ve heard that there are options when it comes to consolidating debt and reducing monthly payments. I know that debt consolidation loans and balance transfer cards are pretty good options, but I can’t figure out which is actually better—and I’m not sure if there are better debt consolidation options out there. When and why would you choose one over the other? I’m scared to make the wrong choice because I’m already struggling to pay my debts. What should I do?

— Indebted to You

Dear Indebted,

I totally understand how confusing it can be when there are so many options. Let’s talk about yours.

Balance Transfer Cards

A balance transfer card is a great option—if you have good or excellent credit. If your debt has already negatively impacted your credit score, you might want to just jump down to the section on debt consolidation loans right now. And if you aren’t sure where your credit is, check out your credit report card before moving forward. It’ll give you a sense of whether or not you’re likely to be approved for a competitive balance transfer credit card or personal loan.

Ok, now that that’s out of the way, here’s what you need to know about balance transfer cards. These cards offer introductory balance transfer rates of 0% APR for several months. From my experience, that is usually a range of about 12 to 24 months. That means you can transfer your existing credit card debt to a new card and avoid paying interest on the balance for the time period allotted. Sounds great, right? They certainly can be great, but they can also cause more problems and more debt if you’re not careful.

Before moving forward with this option, you need to review the terms and conditions of any card you’re considering. There are a few specific things to watch out for:

What happens if you don’t pay the balance off during the intro period and whether the interest is deferred. If the interest is deferred it’s especially important that you pay off the balance before the promotional period ends or you will be charged all the interest that you weren’t charged during the intro period.
The ongoing APR that you will be charged for the remaining balance after the promotion period ends. Balance transfer cards can have high ongoing APRs, so make sure you know what you’re signing up for in the long-term.
If there’s a fee to do the balance transfer. Some cards charge 3%–5% to do the initial balance transfer.
How soon after opening the account you need to initiate the transfer to receive the promotional APR. You may miss out on the opportunity to use the promotional APR if you wait too long to initiate the balance transfer.
Whether late payments result in the loss of the promotional APR. Some cards will void the promotional rate if you make any late payments.

As boring as reading the terms are, it’s very important to know what exactly you are signing up for. And, of course, each credit card issuer is different and has a different set of criteria they look at when underwriting their lines of credit. Review each card carefully to decide whether it is the right one for you.

Check out our credit card marketplace to compare various balance transfer credit cards to get a sense of the terms and conditions these cards require. We’ve done our best to gather what we think are the best balance transfer cards, but not every card will work for your needs. Review each card’s terms and conditions carefully to decide whether it is the right one for you.

Once you understand the terms, figure out how much you need to pay each month in order to pay off the entire balance before the promotional period ends. If you transfer over $5,000 and have an intro APR for 18 months, for example, you will need to pay roughly $278 each month to pay it off. You will want to take this option only if you can afford to pay that amount every month.

Remember: don’t use the card! You will likely also get 0% APR on purchases so it will be very tempting to use the card for new purchases. Remember the whole point of the balance transfer is to pay off your debt—not get into more debt. It might be a good idea to cut up the card when you get it so you aren’t tempted to use it.

Debt Consolidation Loans

If your credit is fair, a debt consolidation loan might be a better option.

When you use a personal loan for debt consolidation, you will use the funds from the new personal loan to pay off your other debts and will make one payment to the new lender going forward. These loans charge simple interest, rather than the variable rates most credit cards offer, and usually have repayment terms of three to five years. The great thing about personal loans is that you know exactly when you’ll be debt free—as long as you make all your payments on time.

However, the interest rates on these loans can be high—especially if your debt has hurt your credit—so you will want to do your research and see what terms are available at various financial institutions. To get a sense of the loans you may qualify for, you can review our personal loan offers. If you decide to search for online personal loans, beware of scams! Look for trustworthy sites and always do your due diligence before signing anything.

If you are specifically looking for lower monthly payments, you will want to check out what options are available for repayment periods. Typically, the longer the repayment period, the lower the monthly payment will be—but you will likely end up paying more interest in the end. If you aren’t able to keep up with the higher monthly payments, though, paying a bit more in interest will be worth the headaches you’d cost yourself in late fees and hits to your credit score otherwise.

This option can also help your credit score by lowering your credit utilization rate if you’re maxed out on your credit cards. Your credit score will take a slight dip due to the hard inquiry when you apply. And if you end up closing any older accounts after consolidating their debt, your score may drop due to the loss of account mixture and age. You’ll want to weigh all these considerations as you’re deciding the best course of action for your situation.

Other Debt Consolidation Options

When you are behind on your payments and being hounded by creditors and collections agencies, working with a debt settlement company may seem like a good option. There are a lot of risks to your credit score when you work with a debt settlement company, though, so consider this option carefully.

If you get to the point of considering a debt settlement company, you may also want to consider bankruptcy. I know it sounds scary, but it can actually be easier to rebuild your credit after a bankruptcy. Consult with a financial advisor if you think this is a step you need to consider.

Another option to consider is a debt management plan offered by a credit counselor. It won’t necessarily reduce the amount you have to pay, but it can lower monthly payments by reducing interest rates or increasing payment length terms. Find an accredited credit counseling agency via the National Foundation for Credit Counseling. A credit counselor will work directly with your creditors to determine a payment plan that works for you and them, without hurting your credit score.

The good news is that you have options. It’s great that you are working toward a goal to get out of debt. Whatever you decide to do, make sure to commit to your plan so that you can reach your financial goals. Let me know how it goes!

Best of luck,

Tiff

P.S. If you’re still not ready to make a decision, we’ve written a few other articles outlining the pros and cons of debt consolidation options and tips for working with debt consolidation companies. You can check out some content here:

Have a question for Tiff? Email tipswithtiff@credit.com.

Disclaimer: Credit Tips with Tiff provides credit tips and suggestions for you to make the most of your money. Given the quantity of questions we receive daily, we are able to answer only select questions. Your email is not guaranteed a response. We reserve the right to edit and publish questions. If your question is chosen, your identity will remain anonymous. We are not financial experts. If you are in need of specific financial help, please seek the advice of a professional.