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Should I Consolidate My High Interest Credit Card Debt?

Updated on May 23, 2014
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If you have credit card debt, you are not alone: the average American household has close to $16,000 in debt, according to CreditCards.com. In some cases, it might make sense for you to consolidate all of your cards into one simple loan at a lower interest rate. However, in other cases, it might just make sense for you to pay off the cards with the highest rates if you can.

Why credit card debt is the absolute worst

You've heard it time and time again: stay away from credit cards, they are terrible. But why is this exactly?

- Credit card debt comes with some of the highest interest rates you'll ever see on any loan, in addition to outrageous late fees and penalties. For example, if a card comes with an APR of 15% and you owe $10,000, you'd end up paying a whopping $1,500 a year in interest. Keep in mind that the average mortgage interest rate is around just 4%, and the average car loan rate is actually lower than that.

- Credit card debt comes with zero tax benefits, unlike other debt such as home equity debt or student loan debt. For example, when you have a mortgage, you should be able to deduct the interest you pay on the mortgage on your taxes - potentially netting you a bigger tax return each year! The same goes for your student loans.

- To make things even worse, credit card debt can be extremely difficult to get discharged in bankruptcy. One of the main points of bankruptcy is to get a fresh start. However, this means that even though car loans or a mortgage will be wiped out - you'd still be on the hook to pay your student loans!

These are just a few reasons why credit card debt is one of the worst types of debt you can have.

How can you attack your credit cards today?

So you've made the decision to consolidate or pay off some of your credit card debt - but how do you get started.

Here are just a few tips:

#1 Manage your debts

The first step is actually sitting down and organizing all of your debt, from the highest interest to the lowest. You need to have a better understanding of what you owe and at what rate.

If you have cards with a very low balance and a high interest rate, it might just make sense for you to pay off the card in full instead of consolidating all of your loans.

Remember, paying off credit card debt is the priority - car loans and mortgages should come later.

#2 Manage your monthly budget

Do you know exactly how much money you have coming in (income) and how much you have going out (expenses) each month? This is extremely important to understand because any excess cash that is going to savings could be put to better use by paying off your debt.

The first step is to sit down and list all of your income - this will be from any job you work, investment income, pensions, etc. Next, list all of your fixed monthly expenses - think rent, utilities, gas and transportation, food, etc. To put it simply, you should be making more than you spend each month - also known as positive cash flow.

What you are going to want to do is figure out where you can cut back on your expenses. Try to find ways to save money in every possible category. For example, if you are paying $50 for the gym each month, why not quit and exercise outside instead? If you're paying $100 for cable TV, why not switch to cheaper online TV alternatives like Netflix? Are you using coupons at the grocery store? Can you carpool to work instead of driving every day? These are just a few examples.

Remember, savings and checking accounts typically earn little to no interest - meanwhile, paying off a credit card with an APR of 14.9% gives you an effective rate of return of 14.9%, since you are saving on future interest payments. Where else can you get a guaranteed return of 14.9%? (The answer is, nowhere!).

You can track all of your finances online for free at websites like Mint.com or you can use a program like Quicken Deluxe for PCs. These programs will really help you track your spending down to every last dollar.

#3 Check out your credit score and improve it

Your credit score is extremely important - a bad credit score can hold you back from getting approved for a new loan, and your credit also determines the interest rate you'll receive on any loan.

Thankfully, you can get your credit report and score for free once a year at AnnualCreditReport.com. They will provide you with reports from the three major credit bureaus - Equifax, Experian and TransUnion.

Improving your credit score fast can actually be quite easy to do. First, you're going to want to check out your reports to see if there are any errors on it. An error on your report can really be hindering your credit score. Look for any information that doesn't look right - for example, a loan that you did not take out or incorrect late payments that you did not make.

According to MyFico.com, 35% of your credit score is comprised of your payment history - so paying the bills on time every month is the most important thing you can do. Similarly, late payments will really hurt your score.


Real-Life Options for Consolidating Credit Card Debt

If you are swamped by your credit card bills every month and feel that consolidating your loans is the best option to pay them off, you might be making the right decision.

Why should I consolidate?

Again, here are just a few good reasons:

- Save money on interest payments. Getting a new loan with an interest rate of just 2% lower than your current debt could potentially save you hundreds, if not thousands of dollars.

- Reduce your total monthly payments. It's possible that by consolidating, you can lower your amount owed each month.

- Stop creditors from harassing you.

- Avoid bankruptcy.

- Pay off the debt faster!

There are a few ways you can do this:

Consolidate with a Low APR Credit Card: Believe it or not, consolidating your credit card debt with a new credit card by doing a balance transfer could make perfect sense. For example, if you have $10,000 in debt at 14.9% APR, and get approved for a new card with an APR of just 9.9%, you would end up saving a good amount of money on interest.

Another idea is to try to get approved for a credit card that comes with a 0% introductory APR. Some cards will offer the first 12-18 months at 0% interest, followed by a standard rate. During the 0% APR period, you should focus on paying off as much of your balance as you can.

However, you need to be really careful that you don't just run up a new debt on your new credit card. This would put you right back in the same situation as before, or worse.

Peer-to-Peer Lending Loan: Sites like Prosper.com and LendingClub offer consumers a way to consolidate their high-interest credit card debt. These sites tend to offer personal loans with a lower interest rate than credit cards.

The interest rate on these loans is also fixed instead of variable. This means your monthly payment will always remain the same. Many people don't realize it, but with credit cards and their variable rates, your payments could increase if interest rates were to rise. With credit cards, your interest rate could also rise if you make a late payment - something you don't have to worry about with a personal loan.

Home Equity Loan: Do you own a home and have equity in it? This means that the value of your home is worth more than the amount of your mortgage. For example, if your home is worth $200,000, but you only owe $100,000 on your mortgage, you have $100,000 equity.

If this is the case, you may be able to qualify for a home equity loan. The interest rate on this loan should be far, far lower than credit cards because you are using your home as collateral for the loan. As mentioned previously, you may also be able to deduct the interest from the loan on your taxes. Like a peer-to-peer loan, your payments will be fixed and never change.

A home equity loan could be your best option, but you need to understand that it works just like a mortgage - if you can't make the payments, you could lose your home.

Loan from a local credit union: Head to your local credit union to see if you can get approved for a debt consolidation loan. Why? Credit unions aren't banks: they are non-profits which are owned by their customers. This is one reason why credit union interest rates are lower than other financial institutions. Credit unions will probably require you to become a member for service, but the benefits should be worth it.

Credit Card Debt By Age

Average credit card debt by age, according to Justice.Gov.
Average credit card debt by age, according to Justice.Gov. | Source

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