How to Recover from Credit Card Debt with a New Loan
How to Recover from Credit Card Debt with a New Loan
Credit card debt can be a major source of stress and financial burden for many people. According to the Federal Reserve, the average credit card debt per household in the U.S. was $5,315 in March 20231. If you are struggling to pay off your high-interest credit cards, you may be wondering if there is a way to get out of debt faster and save money on interest. One possible solution is to consolidate your credit card debt with a new loan.
Credit card consolidation loans occur when a new loan is taken out to pay off your existing debts. For simplicity, let’s say you have three credit cards with balances of 1,000 each and an average interest rate of 20%. A consolidation loan would be taking out a loan for 3,000, paying off your three 1,000 balance credit cards and now just having a single loan for 3,000. The idea is that the new loan will have a lower interest rate and a fixed repayment term, which can help you reduce your total interest cost and pay off your debt faster.
However, consolidating your credit card debt with a new loan is not a magic bullet. It requires careful planning and discipline to make it work. Here are three tips on how to recover from credit card debt with a new loan.
Tip 1: Compare your options for credit card consolidation
There are different types of loans that you can use to consolidate your credit card debt, such as personal loans, home equity loans, balance transfer cards, or debt management plans. Each option has its own pros and cons, depending on your credit score, income, debt amount, and financial goals. You should compare the available options based on the following factors:
- Interest rate: The lower the interest rate, the less you will pay in interest over the life of the loan. Ideally, you want to find a loan that has a lower interest rate than your current credit cards.
- Loan amount: The loan amount should be enough to cover all your credit card balances. Some lenders may have minimum or maximum loan limits that may not suit your needs.
- Repayment term: The repayment term is the length of time you have to pay back the loan. A shorter term means higher monthly payments but lower interest cost. A longer term means lower monthly payments but higher interest cost. You should choose a term that fits your budget and allows you to pay off your debt as soon as possible.
- Fees: Some loans may charge fees such as origination fees, prepayment penalties, late fees, or annual fees. These fees can add up and reduce the savings from consolidating your debt. You should look for loans that have low or no fees.
- Direct payment to creditors: Some lenders may offer direct payment to creditors, which means they will pay off your credit cards directly instead of giving you the money. This can simplify the process and prevent you from spending the money on other things.
You can use online tools such as Forbes Advisor or NerdWallet to compare different lenders and find the best credit card consolidation loans for your situation.
Tip 2: Create a realistic budget and stick to it
Consolidating your credit card debt with a new loan can help you save money on interest and pay off your debt faster, but only if you make your monthly payments on time and in full. To do that, you need to create a realistic budget that accounts for all your income and expenses, including your new loan payment. A budget can help you track your spending habits, identify areas where you can save money, and allocate funds for your financial goals.
To create a budget, you can use a simple spreadsheet or an app such as Mint or YNAB. You should start by listing all your sources of income and all your fixed and variable expenses. Then, subtract your expenses from your income to see how much money you have left over each month. This is your disposable income, which you can use to pay off your debt, save for emergencies, or invest for the future.
You should aim to spend less than you earn and allocate at least 20% of your income toward paying off your debt. If possible, try to pay more than the minimum payment on your new loan to reduce the interest cost and shorten the repayment term. You should also avoid using your credit cards while paying off your consolidation loan, as this will only increase your debt and defeat the purpose of consolidation.
Tip 3: Seek professional help if needed
Sometimes, consolidating your credit card debt with a new loan may not be enough to solve your financial problems. You may have too much debt, too low income, or other issues that prevent you from making progress on your debt repayment plan. In that case, you may need to seek professional help from a reputable credit counseling agency or a bankruptcy attorney.
A credit counseling agency can provide you with free or low-cost advice on how to manage your debt, budget, and credit. They can also help you enroll in a debt management plan, which is a type of consolidation where you make a single monthly payment to the agency, and they distribute it to your creditors. A debt management plan can lower your interest rates, waive fees, and reduce your monthly payments. However, it may also affect your credit score, require you to close your credit cards, and take three to five years to complete.
A bankruptcy attorney can help you file for bankruptcy, which is a legal process that can eliminate or restructure your debt. Bankruptcy can offer you a fresh start, but it also has serious consequences for your credit score, financial future, and personal life. Bankruptcy should be considered as a last resort, only if you have no other way to pay off your debt.