Reasons to consolidate debt
Debt consolidation can be a great way to streamline debt repayment and save money. Here are a few reasons to consider consolidating debt.
- Simpler payments: If you’re struggling to keep up with multiple monthly payments, consolidating can roll them into one, simplifying your finances.
- Interest savings: Securing a lower rate can reduce the interest you’re paying. However, lower rates aren’t guaranteed. Your interest rate depends on factors like the market and your credit profile. Pay attention to the loan’s term – a lower interest rate with a longer term may mean paying more over time.
- Lower monthly payments: Through a lower interest rate or longer term, you may be able to reduce the amount you owe each month. Just remember that a longer term can mean paying more interest overall.
- Potential credit benefits: Accidentally missing a payment is harder when you only have one each month. Timely payments can build a positive payment history and boost your credit over time. Paying off credit card debt can help you lower your credit utilization, too (that’s the percentage of total available credit you’re using).
Ways to consolidate credit card debt
There are a few ways to consolidate debt. Here, we’ll look at three popular options – balance transfer credit cards, personal loans and using your home equity.
Personal loans
A personal loan allows you to borrow a lump sum. Personal loan funds are flexible and can be used for almost anything, including paying off credit card debt. Personal loans are unsecured, which means they’re not backed by an asset (like a car or home). Approval depends on factors like creditworthiness, income and debt-to-income ratio (DTI). The amount of debt you can consolidate will depend on the loan amount you qualify for.
You pay back a personal loan in fixed monthly installments until the term ends and the loan is repaid. Personal loans can be easy to budget for, since they typically offer fixed interest rates and set payments.
Securing a personal loan with a comparatively lower interest rate may reduce your interest expenses overall. However, it’s important to be aware of the term – a longer term, even with a lower interest rate, can mean paying more in interest over the life of the loan.
Balance transfer cards
A balance transfer credit card lets you move credit card debt to a new card. Some balance transfer cards offer a low introductory APR for a promotional period, which typically lasts a set number of months.
The promotional period gives you a chance to pay off outstanding debt while accruing less interest. If you have a balance left over when the promotional period ends, it starts to incur interest at the regular rate.
It’s important to note that you’ll generally have to move outstanding balances to a different card issuer. You cannot transfer debt from one credit card to another from the same issuer. You’ll also pay a balance transfer fee (usually a percentage of the balance or a flat fee, whichever is higher) on each balance transferred. The amount you can transfer will depend on your limit.
Using home equity
If you own a home, you may be able to borrow against your equity to consolidate credit card debt. This involves using your home as collateral for a secured loan. You may get higher borrowing limits compared to personal loans or balance transfer cards, but you risk losing your home if you can’t repay the debt.
Here are some ways to consolidate debt using your home equity:
- Home equity loan: This lets you borrow a lump sum that you’ll pay back with interest over the term.
- Home equity line of credit (HELOC): A HELOC is a credit line tied to your home’s equity, typically with a variable interest rate.
- Cash-out refinance: This option replaces your existing mortgage with a larger loan. You can use the extra cash for a range of expenses, including to pay off credit card debt.
Does debt consolidation hurt your credit score?
Combined with responsible financial habits, debt consolidation can generally help your creditworthiness over time. A positive repayment history and having less credit card debt can improve your credit. On the other hand, Late or missed payments can harm your creditworthiness. There may be some short-term negative effects associated with debt consolidation, too. For example, obtaining any new loan or credit card requires a hard credit inquiry, which may lower your credit score slightly for a short period.
Here’s how different debt consolidation methods may affect your credit score.
- Balance transfer card: Opening a new balance transfer card may lower your credit utilization ratio if you keep other credit accounts open. Your utilization is the percentage of available credit currently in use. So, adding a new line of credit can mean more available credit overall. However, closing old credit accounts after transferring your balance not only may lower the average age of your accounts but also reduces your available credit and raises your credit utilization.
- Personal loan: A personal loan can add to your credit mix if it’s a new type of debt. Your credit mix – the types of credit and loans you have – has a small impact on your creditworthiness. Consolidating debt with personal loan can also improve your credit utilization. This is because moving revolving (credit card) debt to an installment loan (personal loan) lowers the amount of available credit you’re using.
- Home equity-based options: Like a personal loan, a HELOC, cash-out refinance or home equity loan may diversify your credit mix. Whether it affects your utilization can depend on the type of loan and credit scoring model.
Which debt consolidation method is right for you?
The best debt consolidation method depends on your unique situation. Consider factors like the amount of debt you have, the monthly payment you can comfortably afford and a repayment timeline that makes sense for you. Your creditworthiness will also help determine your options.
Repayment timeline: If you need more time to repay what you owe, personal loans and home equity loans may offer longer timelines. On the flip side, balance transfer credit cards may offer short promotional periods that suit people with less debt or more disposable income.
Monthly payment: A personal loan or home equity loan can be a better fit if you prefer fixed monthly payments.
Credit profile and eligibility: Consider the options available to you. Getting a balance transfer credit card with a good introductory offer or a personal loan with a low interest rate depends on your creditworthiness. You typically need to build a certain amount of home equity before you can borrow against it. Many lenders offer online tools that can help you find out whether you pre-qualify for a loan or line of credit. While pre-qualification isn’t a guarantee, it can give you an idea of your options.
Deciding whether to consolidate credit card debt
Before consolidating debt, ask yourself a few important questions:
- Can you qualify for favorable terms?
Good credit can help secure lower interest rates.
- Will you save money?
Make sure fees and interest don’t cancel out potential savings.
- Can you afford the monthly payments?
Even with a lower interest rate, a new loan or credit line generally still requires consistent payments.
- Are you committed to avoiding new debt?
Consolidation can help, but only if you avoid accumulating more debt in the future.
Sometimes, debt consolidation won’t save you money but can make payments more manageable. If that’s your goal, it may still be worth considering.
Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.
