What Is Credit Card Consolidation & How Does it Work?

According to Experian, the average consumer debt in 2023 for each U.S. state ranged from $65,547 – $166,186, and according to the 2023 Small Business Credit Survey, 9 out of 10 small businesses experienced financial or operational hardships. While small business lending did decline year-over-year, it’s clear that inflation and fluctuating interest rates have consumers and businesses alike tightening their belts and looking for financial solutions.

If you’re finding yourself juggling personal or business credit card debt, you may have started considering credit card debt consolidation.

But what exactly is credit card consolidation? How does it work? Is it a wise financial decision, and does it actually save you money in the long run?

We’re here to explain all of your credit card debt consolidation questions and help you find the best debt reduction option for your situation.

What Is Credit Card Consolidation?

Credit card debt consolidation is the process of borrowing money to pay off your existing credit card debts, which results in you having a single debt to pay off rather than several.

This single debt will typically have a lower interest rate than your original debts, especially if the majority of your debt is with high-interest credit cards. This way, you’ll save money and make the repayment process more manageable.

How Does Credit Consolidation Work?

Credit card consolidation works by taking multiple credit card debts and finding a solution to borrow the cost of your total debts (usually a balance transfer credit card or loan), thereby consolidating all of your debts into one single debt.

The exact ins and outs of how credit card consolidation works will depend on which method you use and how much debt you have.

There are several different ways to consolidate your credit card debt, and each method comes with its own pros and cons.

Here are the five most common credit card consolidation options:

• Transfer your debt to a 0% balance transfer credit card
• Take out a personal loan
• Take money out of a retirement account
• Take out a home equity loan or line of credit
• Find a nonprofit credit counseling organization

So which option is right for you? Let’s dive into the pros and cons of each option.

Transfer Your Debt To A 0% Balance Transfer Credit Card

Arguably the most common credit card debit consolidation method is getting a balance transfer credit card. These cards will usually offer an 0% APR introductory period, generally between 12-15 months but occasionally longer, on all credit card balances you transfer over to the card within a certain time frame (typically within 30-60 days of getting your card).

If you manage to pay off your debt on the card within the interest-free period, you can avoid paying any further interest on your debt.

This is one of the safer means by which you can consolidate your credit card debt, as you won’t be putting your house on the line or anything. However, these balance transfer credit cards often require good to excellent credit in order to qualify, thus excluding a lot of indebted people.

While these cards won’t charge interest on your balance transfers for a certain length of time, these cards often have a balance transfer fee of about 3% of the total balance being transferred, which can add up to a pretty hefty fee depending on the amount of debt you have.

Additionally, the credit limit on your balance transfer credit card may not be high enough to accommodate you transferring all your existing credit card debt to the balance transfer card. If you have an enormous amount of credit card debt, it won’t be easy to find a balance transfer credit card that can accommodate all of it.

Our list of the best business credit cards includes some competitive 0% APR card options.

Take Out A Personal Loan

Personal loans can be obtained from a bank, credit union, or online lender and can be used to pay off your credit card debts. Your interest rate will typically depend on your credit. Some online lenders even offer loans tailored specifically for debt consolidation.

Is a personal loan the right debt consolidation method for you?

Unfortunately, it depends on your credit score.

If you have good to excellent credit, you should be able to obtain a loan with a low interest rate that will save the borrower money on interest payments.

If you have poor credit, you may have trouble obtaining a loan with a low interest rate. Being able to qualify for a low rate could negate the debt-consolidation benefits of the loan entirely. If this is you, you may want to check with a credit union before you go to other types of lenders. Credit unions tend to be more likely to accommodate borrowers with low credit scores than other types of lenders.

Take Money Out Of A Retirement Account

If you find that better debt consolidation options aren’t available to you, you can try borrowing from your employer-sponsored retirement account (such as a 401(k) or an IRA).

If you don’t have the credit to qualify for a balance transfer card or loan with a low interest rate, this could be an option. However, this isn’t a debt consolidation method of first resort, as the downsides are serious.

If you go with the 401(k) loan route, you’ll have less money in your retirement account, you might have to pay income taxes and an early withdrawal penalty, and if you’re borrowing from your 401(k), you’ll have to repay the loan within 5 years (and if you lose your job, you’ll have to repay the loan within 60 days!). The consequences are worse if you can’t repay your loan. You’ll get hit with a big penalty as well as taxes on the unpaid balance, and you’ll be in more debt than ever.

Unless your circumstances are truly desperate, I wouldn’t recommend this method of consolidating your credit card debt.

Along the same vein, you may be able to take an early 401(k) withdrawal rather than a 401(k) loan, depending on your retirement plan’s withdrawal rules. This carries the same issue of having less money in your retirement account and incurring income taxes and an early withdrawal penalty, but you wouldn’t run the risk of having to pay back the loan.

Take Out A Home Equity Loan Or Line Of Credit

Here’s another high-risk debt consolidation method: You can borrow against the equity in your home (or possibly your vehicle) with a loan or line of credit. The repayment period can vary from 5 to 20 years but is commonly 10 years.

On the plus side, as this loan would be secured, you’ll get a lower interest rate than you’ll get with an unsecured loan, and you won’t need good credit. On the downside: if you can’t make your payments, you risk losing your home as collateral.

Due to the huge risk, this is another debt consolidation method of last resort. You don’t want to put your house at risk unless you’re supremely confident in your ability to repay the loan. And even then, you could still end up being wrong!

Find A Nonprofit Credit Counseling Organization

If you’d like some personal attention to your specific debt situation, you can try to seek out a credit counseling organization. These organizations work with debtors on a one-on-one basis, offering advice and assistance in creating plans to help you climb out of debt. I would suggest looking for a nonprofit credit counseling organization accredited by the National Foundation for Credit Counseling (NFCC).

These organizations can help you set up a debt management program in which you make payments to the counseling agency in question. The agency then makes payments on each of your debts. They may even be able to negotiate lower interest rates or monthly payments for you.

The downsides to this debt consolidation approach are comparatively minor. You’ll probably have to pay a monthly service fee and a setup fee, and you may be required to close your credit cards after paying them off, which could negatively impact your credit score. If your goal is to pay off debt quickly, the monthly service fee may not be the best use of your money, but if you are totally in over your head and want professional help, this could be an option.

Just make sure you heavily research the company you work with, read reviews from real customers, get recommendations, and make sure all fees are clear upfront before entering this sort of agreement.

Common Debt Consolidation Pitfalls To Avoid

Every debt consolidation method carries particular risks.

For instance, if you take out a personal loan to pay off your credit cards but then continue to rack up charges on your credit cards, you’ll have only added another debt to your debt pile with your personal loan.

Likewise, a homeowner may take out a home equity loan or line of credit and use the money to pay off credit card debts. But if — for whatever reason — you can’t make your HELOC payments, you could lose your home.

While there are a number of ways you can try to hoist yourself out of credit card debt, always be aware of the hazards associated with each method.

The surest method to fight credit card debt is to keep out of debt in the first place. If you choose to consolidate your credit card debt, try cutting excess expenses and lifestyle luxuries so you can throw as much extra cash at the principal as possible. The best way to quickly get out of debt, is making extra principal payments and taking advantage of those 0% APR windows while you have them.

When Should You Consolidate Credit Card Debt?

When done right, consolidating your credit card debt can leave you in a better financial position than when you started and should make it easier for you to pay down your debt. But if you’re not in a position to be able to stop making new credit card charges, you won’t be any closer to your goal of paying off your debt. Likewise, a decent credit score is an unfortunate prerequisite for certain debt consolidation methods (like a personal loan).

While anybody buried under credit card debt can take advantage of one debt consolidation method or another, the method must match your individual circumstances.

We recommend low-risk debt consolidation options like a balance transfer credit card or low-interest rate personal loan. Make sure that your balance transfer fee or loan origination fee is significantly lower than the interest charges you’re experiencing every month; otherwise, you’re better off continuing to make payments on your existing cards.

Higher risk options, like taking a loan against your house of 401(k), come with serious risks. These options should be an absolute last resort if used at all. Before choosing one of those options, try improving your credit score first so you can qualify for the low-risk debt consolidation options instead.

The Bottom Line On Credit Card Debt Consolidation

When overwhelmed by debt, it’s tempting to look for the quickest, easiest path out. Unfortunately, paying down debt is a process that takes time. Even if you are a good candidate for credit card debt consolidation and have the credit score to unlock low rates on a balance transfer card or a loan, this doesn’t mean your debt will go away overnight.

Consolidating debt can be a good first step, but you’ll still have to put in the hard work of making monthly payments and taking on extra principal payments as able to get your debt gone. The more you pay down your principal, the less interest you’ll pay overall, especially if you lower your interest rate with credit card consolidation.

Once you’ve consolidated your credit card debt, be sure to monitor your credit score regularly. Thankfully, there are several reliable free credit score sites where you can monitor your score easily. Check out our content on improving personal credit scores and improving business credit scores for more credit-building tips and tricks.