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A new year is a time for resolution-making, and in 2023 you may be especially determined to get control of your finances. For many, that means eliminating high-interest credit card debt.
Credit card balances were up 15% in the third quarter of 2022 compared to the same quarter in 2021 — the largest increase in 20 years — according to the Federal Reserve's most recent household debt and credit report. Delinquencies, though still at historic lows, are also increasing. And thanks to higher interest rates, carrying a balance is more expensive, making it easier to fall deeper into debt.
But there's a strategy that can help. Debt consolidation, a process that rolls multiple debts into one monthly payment at a lower interest rate, can be a life raft for those who can't get out of debt by making the minimum payments alone.
Follow these three steps for consolidating your credit card debt in the new year.
1. Choose the best consolidation tool for your credit score and debts
Two main tools for consolidating credit card debt are a balance-transfer credit card or a debt consolidation loan. Both work by rolling your existing debts into a single payment.
With a balance-transfer card, you move higher-interest credit card balances onto it and then pay down the debt at a lower rate. In addition, most balance-transfer cards come with an initial 0% promotional period, typically lasting 15 to 21 months, in which you won't accrue interest, so you can get out of debt even faster.
Balance transfer cards sometimes charge a transfer fee — typically 3% to 5% of the total transferred — and are only available to borrowers with good credit (690 credit score or higher).
A debt consolidation loan is a personal loan available to borrowers across the credit spectrum through online lenders, banks or credit unions. By using this loan to pay off your credit cards, you'll be left with one monthly payment that's fixed over the life of the loan, usually two to seven years. In addition, personal loans tend to have lower rates than credit cards, so you should still save money on interest.
Tiffany Grant, an accredited financial counselor based in Greensboro, North Carolina, says she doesn't have a strong preference between the two options but encourages clients to consider credit scores.
"Because these products function in the same way, it's more about what you can get approved for," Grant says. "Some people can't get approved for a 0% interest rate card, so maybe they have to do a low-percent personal loan."
Plugging your balances and interest rates into a debt consolidation calculator can also help you choose since it'll show the extent of your debt. For example, a balance-transfer card is a good fit only if you qualify for a high enough credit limit to cover your debt and pay it off during the promotional period.
If the difference in interest rates between a consolidation tool and your existing debt is minimal — think a couple of percentage points — it may be better to forgo consolidation and not risk the hit to your credit score from applying for a new credit product, says Grant. In that case, consider other ways to pay off debt.
2. Apply with a lender and get approved
Once you've chosen your consolidation tool, it's time to apply.
Applications for balance-transfer cards and debt consolidation loans are usually available online. They may require you to provide personal information like your Social Security number, address and contact details, and income and employment information.
If you're applying for a debt consolidation loan, you may be able to pre-qualify, which lets you view potential loan terms without hurting your credit score. If you can't pre-qualify, pay special attention to the qualification criteria listed on the lender's website, such as a minimum credit score.
When assessing your application, lenders will look for a history of on-time payments, a low credit-utilization ratio and minimal credit inquiries, says Sarah DuBois, a spokesperson with Wells Fargo, which offers both a balance-transfer card and consolidation loan.
You can also take action to boost your chances of approval, says DuBois, like making a payment on an existing balance, which lowers your credit utilization, or disputing an error on your credit report.
Once approved, the following steps will vary based on the product. For example, for a balance-transfer card, you can initiate the transfer of your existing debts either online or by phone with the new card issuer. The transfer can take anywhere from a few days to a couple of weeks.
For a consolidation loan, you may receive the funds in your bank account, which you can use to pay off your credit cards. Other lenders may send the funds directly to creditors for you.
3. Keep up with payments and make a plan to stay out of debt
Though consolidation can be a smart move, it's only successful if you pay off the new debt and resist the temptation to run up a balance on your newly freed cards.
Build a budget that prioritizes your new monthly payment so you're not charged a late fee. Late payments can hurt your credit score if reported to the credit bureaus.
Also, plan how you'll stay out of debt in the future. Grant says most of her clients aren't in debt because of poor spending habits but because they couldn't cover unexpected expenses, such as car repairs or medical bills.
Grant recommends building up to a $1,000 emergency fund to prevent a cash shortage. And don't wait till you're out of debt to start, she says, since unexpected expenses can pop up anytime, causing you to backslide.
Instead, set aside whatever cash you can manage into an interest-earning savings account while still making your new monthly payment.
"Maybe it might take a little longer, but you can do both, and in most situations, that's ideal," Grant says.