If you’re looking for the cheapest way to pay down your high-interest credit card debt and you have a good credit score, you have options, including balance transfer credit cards and unsecured personal loans. Either choice will help you consolidate your credit card debt and eventually become debt-free, but there are several factors you should consider while weighing a balance transfer versus a personal loan.
Snapshot: Balance transfer credit card vs. personal loan
|Balance Transfer Credit Cards
|Type of debt
||Better for smaller debt that can be paid off in full in a shorter amount of time||Better for larger amounts of debt that may take years to pay off|
|Repayment terms||Need to pay the balance in full by the end of the 0% APR period||Need to make fixed payments each month for the entirety of the loan|
||Likely will need a good to excellent credit score to get approved||Likely will need a good credit score, but bad-credit loans are also available|
|Fees||A balance transfer fee is one to look out for. It can be around 3% to 5% of the balance you transfer.||An origination fee is one to look out for. It can be around 1% to 8% of the total loan amount.|
What is a balance transfer credit card?
A balance transfer credit card is a credit card that can help you pay off your high-interest debt by transferring your existing debt onto a credit card with a 0 percent APR intro period. A balance transfer credit card has the potential to save you money and future debt if you pay off the debt within the zero-interest introductory period.
Balance transfer credit cards can be helpful financial tools to help you chip away at that looming pile of debt, but they must be used intentionally. Balance transfer cards tend to have higher interest rates than other credit cards. If you fail to pay off your balance at the end of the introductory period, you could be stuck with more high-interest debt.
Using a personal loan for debt consolidation
Using a personal loan to consolidate your debt can make the debt repayment easier and more accessible. Typically, a personal loan will have a lower interest rate than your other debts, so in certain situations, it makes sense to consolidate your debt with a personal loan. You’ll do this by paying off your existing debts with personal loan funds, then entering the personal loan repayment period.
Consolidating your debt doesn’t mean that your payments are stalled or that your debt is gone, it means that you’ve moved your debt around. So while the interest payments may be less, you’ll still need to be diligent about paying off the loan on time and in full.
While a personal loan can be useful for consolidating your high-interest debt, it may not be the right decision for every situation.
Here’s when a personal loan makes sense:
- You’re consolidating high-interest credit card debt.
- You have a budget prepared to avoid collecting more debt.
- You have an achievable financial plan in place to pay off the loan.
- Your credit score is high enough to get an interest rate lower than that of the debt you’re consolidating.
Here’s when a personal loan may not make the most sense:
- You have high levels of debt.
- You can’t get a lower interest rate on your loan.
- You don’t think you’ll be able to make the monthly payments.
- The fees of the personal loan make paying off the debt more costly and difficult.
Whether or not you should take out a personal loan to consolidate your debt is a decision that you need to make based on your financial health and history. If you think it’s the right option for you, exploring your personal loan options and shopping around with different lenders is the best way to start the process.
Balance transfer credit card vs. a personal loan
Before you decide how to consolidate your debt, you need to know the differences between a balance transfer card and a personal loan. Choosing the right option based on your situation can help you save potentially thousands of dollars.
Here are five things to think about when deciding between a balance transfer card and a personal loan.
This is the first, and probably most important, thing to look at when comparing credit cards and personal loans. With a 0 percent card offer, there’s an interest-free period upfront, but rates after the introductory offer are generally higher than an interest rate on a personal loan. This is especially true if you have good credit, says credit expert John Ulzheimer.
However, there’s virtually no such thing as an interest-free personal loan. With good credit, you can find a personal loan with an interest rate in the single digits, though you’ll be pressed to find close to a 0 percent APR loan. The average interest rate for a personal loan ranges from 4.99 percent to 35.99 percent. The average credit card rate (after the 0 percent intro period is over) is a variable 16.04 percent, as of late July 2020.
How long the 0 percent interest period lasts is also a key consideration. Ask yourself what your total amount of debt is and what payment you’d have to make to pay it all off before your 0 percent interest period ends. Do the math. If you can afford the monthly payments to pay off your debt before interest kicks in, then a balance transfer card could be right for you. If it’s not, you may want to consider a personal loan.
Balance transfer fee
Many balance transfer offers include a one-time fee, which can add up to about 3 percent to 5 percent of the total debt transfer, says Thomas Nitzsche, a communications lead at Money Management International.
For example, if you want to transfer $5,000 to a new card that charges 0 percent interest for 12 months, you might be hit with a fee of $150 to $250. That’s still cheaper than a 12-month personal loan with an 11 percent interest rate, which would lead you to pay $303 in interest.
At the end of the day, you want to find the loan transfer option that lets you pay the least amount of interest possible.
Use our debt consolidation calculator to see which option is cheaper for you.
If you look to an online lender for a personal loan, know that many of them charge a loan origination fee, a one-time charge that is taken out of the total amount you receive. Banks and credit unions typically do not charge an origination fee on personal loans.
These fees can be as high as 6 percent of the loan. In other words, if you asked for a $5,000 loan to consolidate credit card debt, you might receive $4,700, with a $300 origination fee deducted from your balance. Origination fees are typically included in the loan’s annual percentage rate.
Fixed rates, payment schedule
Ulzheimer says that he favors personal loans in this situation because the interest rate never changes and the loan has a fixed payoff date. With predictable payments, a personal loan can help with budgeting. If you’re not managing a credit card absolutely perfectly, then you may end up paying more for a longer time than you would have with a personal loan.
Steve Repak, a North Carolina-based CFP professional and author of “6 Week Money Challenge,” says he favors a balance transfer because it’s more flexible than a personal loan.
“What if you lose your job or what if something comes up, some type of financial emergency where you can’t make that $500 payment?” Repak says. “A 0 percent transfer might give you some flexibility even though it might cost you more. With a fixed payment, you’re kind of stuck with that.”
As you’re deciding how to consolidate debt, look at your situation to see which makes sense for you. If you need help with budgeting and want fixed payments, a personal loan is a good option. If you’d prefer flexibility, a balance transfer credit card may be right for you.
Opening up a new card and transferring all of your credit card balances to it might push the utilization ratio on that card close to 100 percent, which could hurt your credit score. Credit-scoring models also place a negative emphasis on revolving debt, so if you keep transferring the debt from one card to another, your score could go down even more.
On the other hand, taking out a personal loan to consolidate debt could lower your utilization rate to 0 percent. That could help your score. Though you aren’t really getting out of debt, just converting it, the credit-scoring models don’t see it that way, so your credit score could rise — as long as you make timely payments on your loan.
Calculate your personal loan payments
When it comes to deciding if a personal loan is the right option for you, the monthly payment is one of the most important things to consider.
Bankrate’s personal loan calculator can help you determine your monthly loan payments and how much you would pay in principal and interest.
While balance transfer credit cards and personal loans are useful financial tools, they both have their pros and cons. Before you start your debt consolidation journey, make sure you do the proper research to ensure that the decision you make is the right one for your financial situation.
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