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If you’re looking for an inexpensive way to pay down your high-interest credit card debt and your credit score is in good shape, you have several debt consolidation options to consider.
Two of the most popular methods to help pay down debt and save money along the way are balance transfer credit cards, which let you transfer debt from other sources and pay as low as 0 percent interest for an introductory period, and debt consolidation loans, which are unsecured personal loans that you use to pay off your other debts, often at a lower interest rate.
6 factors to consider when consolidating your debt
Before you decide how to consolidate your debt, you need to commit to a strategy that is going to keep you from falling back into debt. Choosing the right option based on your situation could help you save thousands of dollars or make the process much easier based on your personality or circumstances.
As you compare debt consolidation loans and balance transfer credit cards, think over how each option might work based on the amount of debt you have. Here are six factors to consider when deciding between a balance transfer card and a debt consolidation loan.
1. Interest rates
Interest rates are the first — and probably most important — thing to look at when comparing credit cards and debt consolidation loans. Balance transfer credit cards offer an interest-free period upfront, but rates after the introductory period are generally higher than interest rates on personal loans. 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 personal loan. As of December 14, 2022, the average interest rate for a personal loan is about 10.72 percent, while the average credit card interest rate is hovering above 18 percent.
How long the 0 percent interest period for a balance transfer credit card lasts is also a key consideration. Ask yourself what your total amount of debt is and the average payment you’d have to make to pay it all off before your 0 percent interest period ends. If you have $5,000 in credit card debt and 0 percent APR for 18 months, for example, could you afford to pay $278 per month during that timeline to become debt-free?
If you can afford the monthly payments to pay your debt off before interest kicks in, then a balance transfer card could be right for you. If not, you may want to consider a personal loan.
Why it’s important: The interest rate that you pay on a loan is the primary factor in determining your monthly payment. Choosing an option with a lower interest rate can help keep your payments down and give you a better chance of paying your debt off.
Many balance transfer offers include a one-time fee, which can add up to about 3 percent to 5 percent of the total amount of debt you transfer.
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 $302.90 in interest.
If you’re considering a personal loan instead, you should know that some of them charge a loan origination fee — a one-time charge that is taken out of the total amount you receive. However, banks and credit unions typically do not charge an origination fee on personal loans.
Origination fees can be as high as 8 percent of the loan amount in some cases. In other words, if you asked for a $5,000 loan to consolidate credit card debt, you might receive $4,600, with a $400 origination fee deducted from your balance.
Why it’s important: Nobody likes paying unnecessary fees, so make sure that you are aware of what fees will be charged. However, it may make sense to pay some fees to secure a lower interest rate or other favorable terms.
3. Fixed rates and payment schedule
Ulzheimer says that he favors personal loans for debt consolidation because the interest rate never changes and the loan has a fixed payoff date. With predictable payments, a debt consolidation 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 certified financial planner and author of “6 Week Money Challenge,” says that 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 option 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.
Why it’s important: Paying your debt off depends on finding a repayment strategy that you can stick with. Consider whether you’d rather have the certainty of fixed monthly payments with a personal loan or the flexibility of a balance transfer credit card.
4. Credit score impacts
Opening up a new card and transferring all of your credit card balances to it might push your credit 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, which 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.
Why it’s important: Your credit utilization ratio (the amount of your available credit that you’re using) is one of the most important factors in your credit score. Keeping that low can boost your credit score and help you get better rates on future loans.
5. Credit requirements
Debt consolidation loans and balance transfer credit cards do have one important thing in common: Lenders in both spaces offer the best rates and terms to individuals with very good or excellent credit — or any FICO score of 740 or above. With that being said, consumers with “good” credit scores (FICO scores from 670 to 739) might also be approved for either option depending on the lender.
If your credit score is lower than that, it’s unlikely that you’ll find a balance transfer credit card you can qualify for. There are some secured credit cards with balance transfer offers, but they do not give you 0 percent APR for a limited time, and you’ll have to put down a cash deposit as collateral.
Conversely, it’s possible to qualify for a debt consolidation loan with bad credit, but you should expect to pay a higher interest rate overall. With that being said, a bad-credit loan could still help you save money, provided your new interest rate is lower than the current rates you’re paying.
Why it’s important: You’ll want to know what your credit score looks like and how that affects the rates you can get. The better your overall credit profile, the better interest rates and terms you’ll be able to get.
6. Types of debt
As you compare debt consolidation loans and balance transfer credit cards, it can also help to think about the types of debt you have. Generally speaking, debt consolidation loans are a good option if you have multiple types of debt to consolidate. This is based on the fact that debt consolidation loans give you a lump sum upfront, which you can use to pay off medical bills, credit card bills, payday loans and any other debts you have.
By contrast, balance transfer credit cards can be a better option if you have only credit card debt. This is based on the fact that many balance transfer credit cards only let you consolidate other credit card balances. Balance transfer credit cards can also be a good option for paying down small amounts of high-interest credit card debt due to their relatively short introductory periods.
Why it’s important: Your credit mix factors into your credit score. Having different types of debt can improve your credit score.
Should I get a personal loan or a balance transfer credit card?
If you have high-interest debt you desperately need to pay off, you could make a case for a debt consolidation loan or a balance transfer credit card. However, both options tend to work best for different situations and for different types of consumers.
When debt consolidation loans tend to work best
- People who need to pay down debts over a long period of time, or up to 10 years.
- Anyone who wants the security of a fixed interest rate and fixed monthly payment.
- People who need to stop using credit cards due to the temptation of overspending.
When balance transfer credit cards tend to work best
- Anyone who has a small amount of debt that they can completely pay off during their card’s 0 percent APR introductory period, which will likely last 12 to 21 months.
- People who have the discipline to stop using credit cards even after signing up for a new one.
The bottom line
Either debt consolidation option can work for your needs and goals, but you need to have a plan to get out of debt either way. No matter which option you go with — a debt consolidation loan or a balance transfer credit card — learning to live on less will be the key to your success.