Debt Consolidation Loan vs Balance Transfer Credit Card

If you’re looking for a cheap way to pay off 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 for paying off debt and saving money along the way are balance transfer credit cards, which let you transfer debt from other sources and pay as little as 0 percent interest for an introductory period, and debt consolidation loans, which let you pay off debt transfer from other sources and pay only 0 percent interest during an introductory period. are unsecured personal loans that allow you to pay off your other debts, often at a lower interest rate.

Here are some of the key differences between the two, as well as important factors to consider when making your decision:

6 factors to consider when consolidating your debts

Both debt consolidation loans and balance transfer credit cards have their own pros and cons. The following factors can help you understand how each option will affect your specific financial situation:

1. Interest rates

Interest rates are the first – and probably the 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 personal loan interest rates. This is especially true if you have good credit, says credit expert John Ulzheimer.

However, there is 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, although you’ll have to quickly find a personal loan close to 0 percent. Currently, the average interest rate for a personal loan is around 11.05 percent, while the average credit card interest rate hovers above 20 percent.

How long the 0 percent interest period for a balance transfer credit card lasts is also an important consideration. Look at your total debt amount and the average payment you would need to make to pay it all off before your 0 percent interest period ends. For example, if you have $5,000 in credit card debt and an annual interest rate of 0 percent for 18 months, can you afford to pay $278 per month over that period to become debt-free?

If you can afford the monthly payments to pay off your debt before interest kicks in, then a balance transfer card may be right for you. If this is not the case, you can consider a personal loan.

Why it’s important: The interest you pay on a loan is the most important factor in determining your monthly payment. Choosing a lower interest rate option can help you keep your payments low and give you a better chance of paying off your debts.

2. Costs

Many balance transfer offers include a one-time fee, which can amount 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 could be charged a fee of $150 to $250. That’s still cheaper than a 12-month personal loan with an 11 percent interest rate, leaving you paying $302.90 in interest.

If you are considering a personal loan, keep in mind that some loans charge a one-time fee that is deducted from the total amount you receive. However, banks and credit unions typically do not charge an origination fee on personal loans.

In some cases, origination costs can be as high as 8 percent of the loan amount. In other words, if you ask for a $5,000 loan to consolidate your credit card debts, you might receive $4,600, with a $400 origination fee deducted from your balance.

Why it’s important: No one likes paying unnecessary fees, so make sure you are aware of any fees you may be charged. Take some time to crunch the numbers, though, as it may make sense to pay certain fees to guarantee a lower interest rate or other favorable terms.

3. Fixed rates and payment schedule

Ulzheimer says he prefers 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 also help with budgeting. If you don’t manage your credit card perfectly, you may end up paying more than you would with a personal loan for a longer period of time.

Steve Repak, a North Carolina-based certified financial planner and author of “6 Week Money Challenge,” says he favors a balance transfer because it is more flexible than a personal loan.

“What if you lose your job or something happens, a financial emergency where you can’t afford that $500?” says Repak. “A 0 percent transfer can give you some flexibility, even though it may cost you more. With a fixed fee you are somewhat tied to that.”

As you decide how to consolidate your debts, 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 may be a good option. If you prefer flexibility, a balance transfer credit card may be right for you.

Why it’s important: Your ability to pay off your debts depends on finding a repayment strategy that you can stick with. Consider whether you prefer the security of fixed monthly payments with a personal loan or the flexibility of a credit card with balance transfer.

4. Impact on credit score

If you open a new card and transfer all your credit card balances to it, your credit utilization ratio on that card could be almost 100 percent, which could hurt your credit score. Credit score models also place a negative emphasis on revolving debt, so if you keep transferring debt from one card to another, your score could drop even further.

On the other hand, taking out a personal loan to consolidate your debts could lower your utilization rate to 0 percent, which could improve your score. Even if you don’t actually get out of debt, just converting it, the credit score models don’t see it that way, which can increase your credit score – as long as you pay off your loan on time.

Why it’s important: Your credit utilization ratio (the amount of available credit you use) is one of the most important factors in your credit score. Keeping it low can improve your credit score and help you get better rates on future loans.

5. Credit Requirements

Debt consolidation loans and balance transfer credit cards have one key thing in common: Lenders in both spaces offer the best rates and terms to individuals with very good or excellent credit – or a FICO score of 740 or higher. That said, consumers with “good” credit scores (FICO scores from 670 to 739) can also be approved for either option, depending on the lender.

If your credit score is lower, you’re unlikely to find a balance transfer credit card you qualify for. There are some secured credit cards with balance transfer offers, but they won’t give you 0 percent APR for a limited time and you’ll have to put up a cash deposit as collateral.

Conversely, it is possible to qualify for a debt consolidation loan with bad credit, but you should expect to pay a higher interest rate overall. That said, a bad credit loan can still help you save money, provided your new interest rate is lower than the current interest you’re paying.

Why it’s important: Your credit score affects the products you qualify for and the rates you can get. The better your overall credit profile, the more likely you are to qualify for better interest rates and terms.

6. Types of Debt

When comparing debt consolidation loans and balance transfer credit cards, it can also help to think about the types of debt you have. In general, debt consolidation loans are a good option if you have multiple types of debt to consolidate. This is because debt consolidation loans give you a lump sum upfront, which you can use to pay off medical bills, credit card bills, payday loans, and other debts you have.

Balance transfer credit cards, on the other hand, may be a better option if you only have credit card debt, as most balance transfer credit cards only allow you to consolidate other credit card balances. Balance transfer credit cards can also be a good option for paying off small amounts of high-interest credit card debt due to their relatively short introductory period.

Why it’s important: Your credit mix plays a role in 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 that you urgently need to pay off, you can 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 have to pay off debts over a longer period of time.
• Anyone who wants the certainty of a fixed interest rate and a fixed monthly amount.
• People who have to stop using credit cards because of the temptation to overspend.

Credit cards usually work best for balance transfers

• Anyone who has a small amount of debt that they can pay off in full during the 0 percent APR introductory period on their card, 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.
• People who want the flexibility of maintaining an open line of credit after paying off their debts.

it comes down to

Both debt consolidation options can work for your needs and goals, but it’s important to pair your chosen product with a solid financial plan that will keep you from racking up new debt once your old debt is paid off.

Whichever option you choose – a debt consolidation loan or a balance transfer credit card – learning to live with less will be the key to your success.