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What Is a Credit Card Consolidation Loan?

If you’re struggling with paying off credit card debt, then you may want to consider credit card consolidation. Credit card consolidation allows you to merge your separate debts into one single payment. You can consolidate your debt in a few different ways. One of these ways is to take out a loan. There are pros and cons with this option, so read on to find out if it’s right for you.

Looking to consolidate credit card debt? Check out the best balance transfer credit cards

What Is Credit Card Consolidation?

Credit card consolidation is the process of combining multiple balances of credit card debt into one single balance. Instead of making multiple payments each month to various creditors, you get to make one singular payment. You can consolidate with a balance transfer card or through a loan.

Each consolidation option has its own pros and cons. Benefits include easier payments, an improved credit score and lower interest rates. If you’re in a bad credit situation, credit card consolidation can be a good way to get out of it. Plus, you won’t have to stress about multiple payments and deadlines with only one payment to make.

Despite its benefits, you’ll still want to weigh whether consolidation is the best option for you. The goal of consolidation is to help pay off your debts faster and save some money along the way. If the end result for you means you end up paying less with a shorter payment period, then you may want to look into it.

Credit Card Consolidation Loan Options

What Is a Credit Card Consolidation Loan?

When you consolidate credit card debt through a loan, you put that debt into one loan payment. You can do this with personal loans, home equity loans and 401(k) loans.

You can apply for personal loans from a bank, credit union or online lender. Personal loans usually have low interest rates but your rate will still depend on your credit. As a loan, you’ll have the repayment plan laid out for you, including a fixed amount, interest rate and payment period. With proper management and oversight, you can pay off the loan fairly quickly and easily by paying in full and on time. This can help with saving money and building credit.

Home equity loans provide another loan option for credit card consolidation. Home equity refers to the value of a home, excluding any preexisting loan balances. The less you owe on your mortgage, the more value the home has. Home equity loans use real estate as collateral, meaning your home backs the loan. You’re borrowing against the home’s equity cost. This is also known as taking out a second mortgage.

Interest rates for home equity loans are typically fixed at lower rates than credit cards. These rates are also tax-deductible, making it an attractive option. But there are big risks to taking out a home equity loan, namely putting your home at risk. If you fail to repay the loan, you could lose your home. Not only that, but your credit card debt will remain unpaid.

Your last loan option is to take out a 401(k) loan. This means you borrow from yourself via your retirement savings account. But since you’re the one taking the money out, the money is not paid back. 401(k) loans typically carry lower interest rates, too. However, you’re usually limited to borrowing 50% or lower from your account.

Taking out a 401(k) loan is typically viewed as a last-resort option. This is because it puts your retirement savings at risk. You must have long-term job security, usually five to seven years guaranteed. If you lose your job, you will have to repay the loan in full within 60 days. In addition, the loan limits your ability to invest. You could see heavy penalties for making any late payments, too, further hurting your finances.

Which Credit Card Consolidation Loan Is Best for You?

To start, you’ll have to have a pretty good credit score to obtain a personal loan. The interest rate will vary, but usually a better credit score will get you a better interest rate. Additionally, since a personal loan has a fixed payment plan, you should make sure that you can make each monthly payment.

If you’re unable to qualify for a personal loan, then you can look into getting a home equity loan. A home equity loan can get you lower interest rates than your credit cards carry. So leaving a balance may not cost you quite as much. This can save you money, but you’ll want to keep in mind it might take longer to pay off a home equity loan.

Lastly, you may consider a 401(k) loan. To protect yourself and your retirement, you really should ensure your job security before you take out this loan. It could help if you have other retirement savings accounts like IRAs. Don’t forget that you may not be able to borrow more than 50% of your savings. If you need more than that to pay off your credit card debts, you might have to look elsewhere. Again, be aware of the risks of taking out a 401(k) loan, like depletion from the fund and heavy penalty fees. But with low interest rates, it can be a good option if absolutely necessary.

Whichever option you choose, credit card consolidation should enable you to pay back your loans in a quick and cost-effective way. Choosing an option that’s not quite the best for you can result in even more debt and a damaged credit score. Even worse, if you opt for a home equity or 401(k) loan, you could lose your home or retirement savings, both of which are important assets. Before you commit, be certain that it’s the best fit by doing some calculations. You’ll want to make sure you will save money and shorten the payoff period.

Pros and Cons of a Credit Card Consolidation Loan

What Is a Credit Card Consolidation Loan?

The success of consolidation loans rides on your ability to repay the money. If you make payments late or only in part, you could get hit with some serious penalty fees. In this case, consolidation may be more harmful than beneficial.

When deciding whether to take out a loan or not, you’ll want to pay attention to the interest rate you’ll get. But if a loan’s rates are lower than your credit cards’, you can end up saving a bit of money. If the rates are higher, consolidation may be more draining for the wallet. Remember, if your credit score isn’t great, you will probably see higher interest rates.

In addition, it is important to borrow only what you can handle. Taking on debt to pay off debt produces a vicious cycle. If you can’t pay, you end up putting your assets at risk, decreasing your credit score and subjecting yourself to high penalty fees.

It’s up to you, the consumer, to pay back debts in a responsible fashion. With full and timely repayment, your credit score will eventually improve. There are some risks, but with proper oversight, you can become debt-free through credit card consolidation.

Bottom Line

Credit card consolidation may be a good option for those who hold multiple debts on separate cards. Depending on your financial situation, a consolidation loan can help the repayment by saving some time and money. With the variety of options available, one will most likely fit you and your financial habits.

Photo credit: ©iStock.com/asiseeit, ©iStock.com/Weekend Images Inc., ©iStock.com/fstop123

Emily Zhu Emily Zhu writes on a variety of personal finance topics for SmartAsset. Her expertise includes retirement, credit cards, taxes and banking. She grew up in Brooklyn, but now splits her time between Brooklyn and Rochester. Emily is currently studying at the University of Rochester.
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