3 Good Reasons for Consolidating Credit Card Debt

If credit card bills are dragging down your budget each month, paying them off as quickly as possible can create some much-needed breathing room. When you’re trying to get out of debt, sheer willpower alone won’t cut it; you also need to have a plan for how you’ll pay it down.

Consolidating your credit cards allows you to streamline your payments so you can cross the debt-free finish line that much faster. While consolidation may not be right for everyone, there are some excellent reasons to consider it if you’re tired of handing over you cash to creditors each month.

Reason #1: You want to save money

By and large, the biggest advantage of consolidating your credit cards is the fact that it can potentially save you a tremendous amount of money. If you’ve got four or five cards that you’re paying 10, 15 or even 20 percent interest on, you’re going to have a hard time digging your way out of debt, especially if you’re not able to pay much more than the minimums each month.

Consolidating multiple cards, either through a balance transfer, personal loan, or home equity line of credit, gives you a shot at scoring a lower rate. That means more of what you pay each month goes to the principal, which speeds up your progress and cuts down on what you’re spending for interest.

For example, let’s say you owe $10,000 on four different cards, with an average interest rate of 18 percent. It you pay the minimum of $250 a month, it’ll take you just over five years to pay it off and cost you about $5,400 in interest, assuming you don’t make any new charges.

Now, if you consolidate that amount and roll it into a home equity line of credit with a 5 percent interest rate, you’ll have it paid off in about 3.5 years and pay less than $1,000 in interest. That’s nearly $4,500 extra you’d be able to keep in your pocket over the long run.

Reason #2: You’re trying to boost your credit score

Your credit score is based on a number of factors, including how long your accounts have been open, the types of credit you have and how good you are at paying your bills on time. Late payments and the total amount you owe have the biggest impact so if raising your score is the goal, consolidating your credit cards may work in your favor.

Your credit utilization ratio is the amount of debt you owe versus your total credit line. For instance, if you have five cards that have a $5,000 limit and you’re using $1,000 of your available credit on each one, your credit utilization ratio is approximately 20 percent.

If you were to open up a new credit card with a $5,000 limit and transfer your balances to it, that would increase your total credit line to $30,000 and your credit utilization would drop to 17 percent. As long as you keep your other accounts open and don’t create any additional debt, you should see an improvement in your score.

Reason #3: You own a home

If you’ve built up some equity in your home, shifting your credit card balances onto a home equity loan or line of credit can yield some significant benefits at tax time. The IRS allows taxpayers to deduct the interest they pay towards their primary mortgage but this rule can also be extended to second mortgages.

As of 2015, you can deduct the interest on a second mortgage loan up to $100,000 or up to $50,000 each if you’re married and file separate returns. The catch is that you do have to itemize to claim the deduction so if you normally go the standard route, you may be better off exploring other ways to consolidate your debt.

Comparing consolidation options

When you’re looking at combining your credit cards, the most important things to keep in mind are how much it’s going to cost in terms of the interest and fees. Transferring your balances to a new credit card with a 0 percent interest rate is going to be the best deal in the short term but it’s not always the best way to save money.

Introductory periods are can last as long as 12 or even 18 months but after that, the entire balance is subject to a default rate which can be anywhere from 10 to 20 percent. If you don’t get the debt paid off before the promotional period ends, you may not really be saving that much in the end.

Personal loans and home equity loans usually have rates that are somewhere in the 3 to 10 percent range but they may offer more flexible repayment terms. If you’ve got a substantial amount you’re trying to pay off, spreading it out over three or five years isn’t ideal but if you’ve got a fixed interest rate, you don’t have to worry about a huge pile of interest getting piled on all at once.

When consolidation isn’t a smart move

While consolidating credit card debt is a sensible way to save some money and get rid of your debts faster, it’s not a perfect solution for everyone. If your debt is the result of careless spending, consolidating doesn’t really address the financial problems that landed you under a heap of credit card bills to begin with. If you run the balances back up on your cards again, you’re really no better off than you were before.

Consolidation can be especially dangerous when overspending is an issue if you’re using your home equity to pay it off. If you default on a second mortgage, you may end up in a situation where you’re either having to declare bankruptcy to get rid of the debt or you end up losing your home altogether.

If you’re 100 percent committed to dumping your debt permanently, consolidating may be the right answer. On the other hand, if you’re not sure you can control those spending urges, it could potentially create even more financial problems.