Consolidate! It seems to be the new fad in the world of consumer debt—the magic bullet that will effectively rid your life of all problems with credit card debt.

The advertisers, credit counselors, and financial experts are all shouting out:

“Slash your interest rate!”

“Save thousands of dollars!”

“With one low, monthly payment you’ll have extra money!”

And you know what? Consolidation can be a great option for digging your way out of credit card debt. But what the advertisements don’t tell you is that it’s not a magic bullet. Consolidation is a re-payment plan that is successful only when you are determined to do what it takes to make it work. It will take planning, determination, and a little elbow grease. But you can do it! Here’s what you need to know.

Find the Underlying Cause

The first step in any debt re-payment plan is determining the underlying cause; otherwise, the problem will happen again and again. Typically the problem is not the credit card itself. They are a great tool of convenience and security. Many people use them in a financially responsible way everyday. So if the problem is not the credit card, what is?

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Let’s go ahead and face it. Sometimes the problem comes with just the bad habit of spending too much money. Credit expert Gerri Detweiler, author of The Ultimate Credit Handbook and founder of DebtConsolidationRx.com, says the two largest areas people tend to overspend is in the area of food and transportation. She’s heard of people spending $160 a month at the office vending machine! So maybe it’s time to take a reality check. Spend a month tracking every single expense down to the penny to see where your money is going. Then take the time, and maybe even help from a credit counselor, to setup a budget and a plan to stick with it.

A Life Crisis

Emergencies happen to everyone. Unfortunately people we love die, life-long careers disappear, and, as we’ve all seen in the news lately with Hurricane Katrina, natural disasters create havoc. All too often we are unprepared for such events and we end up putting a lot of expenses on credit cards. As you analyze your budget, it’s a good idea to determine a set amount to save each month for emergencies. Ideally, if your budget allows for it, a good amount is 5-10% of your take-home income. But if you can’t manage that much, then set aside as much as you can.

Big Life Events

Now I’m talking about events we expect—weddings, babies, college educations, family vacations, etc. Don’t let these events sneak up on you without some financial planning. The earlier you start, the better off you’ll be. And if for some reason the anticipated event doesn’t occur, at least you’ve built yourself a nice little nest egg.

Setting Aside Credit Cards for a Time

When you start consolidating debt it’s important not to accumulate any new debt. Trying to deal with a consolidation loan along with new consumer debt only builds layer upon layer of financial trouble. The accounts don’t have to necessarily be closed, but at least put the credit cards in an inconvenient location such as in a cup of frozen water in the back of the freezer, a safe deposit box, or even six feet under in your backyard! Once the consolidation loan is paid off, you’ve brought your finances back under control, and you’ve learned new healthy financial habits, then go ahead and bring them out from hiding if you want.

Lower Payment vs. Lower Cost

A big mistake many people make when consolidating debt is looking at the payment amount alone. Sure you can lump all your payments together into one low monthly payment, but what is your interest rate, fees, and length of the loan? A $5,000 loan at 10% for 15 years with a monthly payment of only $53 will cost you $2,000 more than the same amount at 18% for 5 years with a monthly payment of $126.

Consolidation Options

Now let’s take a look at some of the options for consolidating. When it comes to consolidating your credit card debt you have several options at your disposal, each with its own set of pros and cons. Here’s a brief description of some popular options along with their relative pros and cons.

Low-Rate Credit Cards

If your credit rating is good enough to qualify for a low-rate credit card, possibly even a zero percent introductory rate, transferring all your higher rate credit card balances could be a good option. This option generally works best if you can pay the balance off within one year. Check out our Card Reports section to evaluate different low-rate credit card offers.

Pros

• If you qualify for a low-introductory rate card you may get the benefit of not paying any interest for a time.

Cons

• Excessive transfer and new account activity on your credit history could cause you to have a poor credit score. This is bad when your low-rate credit card expires and you aren't able to qualify for a new card. You could be stuck with a high interest rate.

   

• Watch out for balance transfer fees. Fees could potentially outweigh any interest savings that you might realize.

Home Equity Loan or Home Equity Line of Credit

Because you’re using your home as collateral for this type of debt, it’s imperative that you really understand your repayment plan and deal with the issues that got you into debt in the first place. Detweiler suggests this is not a good option in a hardship or crisis situation, including a job loss, since failure to pay back a home equity loan could result in the loss of your home.

Pros

• Usually a lower interest rate.

   

• Interest is normally tax deductible.

   

• Your monthly payment will usually be lower so you can use the difference between it and your fixed monthly debt payment to start building an emergency fund.

Cons

• You will be trading unsecured debt for secured debt putting your home at risk. If you miss even one payment you could lose your home, whereas if you left it as credit card debt you would still have a place to live.

   

• You could end up paying a lot of money in fees such as closing costs and appraisal fees. Make sure you shop around to find the best deal.

   

• The entire loan must be repaid before you can sell your house.

Personal Loan

Because of the potential effects of high credit card debt on your credit rating it may be difficult to qualify for an unsecured personal loan with a decent interest rate. If your credit rating is good you may qualify for a rate in the low-teens, but if it’s poor you may end up paying around 20 percent. Shop around at a variety of financial institutions including credit unions to compare the cost of fees and interest. And be aware that generally the extra products they try to sell aren’t worth the cost you’ll pay.

Pros

• Can get good rates, especially if you are a member of a credit union and have good credit.

   

• Unsecured so you don’t have to worry about losing your home.

Cons

• Your credit rating could drop further because of credit inquiries, closing old accounts, and opening new accounts.

   

• Additional fees.

Now you’ve got some tools under your belt to help dig your way out of credit card debt. You can also browse our http://www.cardratings.com/crinfofre.html Articles Section for more information about credit cards and debt. Good luck in your quest to be debt free.

Amy L. Cooper-Arnold has been a staff writer for CardRatings.com since 2004. Her articles have been republished by respected publications throughout the country, including Young Money Magazine, E/The Environmental Magazine and About.com. Amy recently graduated with honors from Austin Peay Univ. and is currently taking graduate-level classes.

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