Debt Consolidation Loans vs Balance Transfer Credit Cards
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Handling multiple debts can become stressful and lead to several money troubles. Heck, it could become a huge challenge even if you have one high-interest debt! Americans are dealing with huge difficulties in paying off debt and if you are also struggling, remember, you are not alone. But perhaps now is the time to prioritize paying off the debt. While creating a debt management plan, you may consider consolidating your accounts to simplify the process. There are several ways to do this, but here, we look at two of the most popular: a balance transfer credit card and a debt consolidation loan. Use this guide to determine which, if either, is right for you.
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What is a balance transfer credit card?
A balance transfer credit card means moving the balance from one credit card to another. The idea is to move the debt from a high-interest rate to a lower interest rate, ideally making the most of the 0% annual percentage rate (APR) balance transfer opportunity. Balance transfer credit cards can be a good option if you only have credit card debt. It will only allow you to consolidate the credit card balances and will help pay down small amounts of high-interest debt due to the introductory offer.
Pros and cons of balance transfer credit cards
Pros
- With a 0% APR for the introductory period, you can save money on interest.
- Since there is no interest accrual, you can pay down the debt quickly.
- Many cards do not charge any annual fee and offer rewards like cash back.
Cons
- Some cards charge a fee ranging between 3% to 5% of the transfer amount.
- The introductory period does not last forever, and you could pay a high interest rate if you carry a balance when this period ends.
- Many credit card companies require an excellent score to qualify.
Who should opt for balance transfer credit cards
- Those with a small debt can pay off within the 0 percent APR period.
- Individuals who are disciplined enough stop using credit cards even after they apply for a new card.
Related: Best Balance Transfer Credit Cards
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What is a debt consolidation loan?
The second alternative is a debt consolidation loan. This loan combines several debts into a single loan with a fixed monthly payment and a fixed repayment period. You will get a lump sum upfront, and you can use it to pay off all your debts. The loan could be secured or unsecured. An unsecured loan will have a higher interest rate that varies based on your credit score and credit limit, while secured loans have lower interest rates, but if you default on the loan, you could risk losing the underlying asset. The lender can issue a loan backed by the equity in your home, known as a home equity loan, or any other asset you own. These funds can be used to pay off the existing debts and make a single payment to the lender each month instead of paying multiple creditors.
You can use the loan for several reasons like weddings, medical emergencies, home remodeling, or car repairs. However, they make the most sense when you want to pay off high-interest debt like credit cards. When the loan has an APR lower than the interest rates on your credit cards, it will help you save money by paying the credit card balance using the new loan. If you want to go debt-free, one of the most effective ways is to approach a debt consolidation company. However, they will charge a fee for their services. You can approach a credit counselor first, who will try to understand your debt problem and offer the right solution. Credit counseling is an ideal way to handle debt and is a long-term solution if you want to remain debt-free.
Pros and cons of debt consolidation loans
Pros
- You can consolidate different types of debt into one.
- Many lenders pay off the creditors directly, making the debt consolidation process easier for you.
- If you have a strong credit score, you can borrow a lot and enjoy a long tenure to pay it off.
- The monthly payments and fixed interest rates make budgeting easier.
- The combined monthly payments are easier to manage than several different loans.
- Helps improve your credit score.
Cons
- Without a strong credit score, you might get a higher interest rate.
- Many lenders charge an origination fee, eventually neutralizing the benefit of low-interest rates.
- The interest charges will be applicable from the beginning since there is no introductory period.
Who should opt for debt consolidation loans
- Individuals who want the security and peace of mind of a fixed monthly payment and interest rate.
- People who have to pay down debts over a long period of time.
Related: Best Debt Consolidation Loans
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Differences between balance transfer credit card and debt consolidation loan
Balance transfer will only transfer the balance on one or more of the credit cards into a new card, usually with a 0% APR introductory offer which spans 12 to 21 months. If you pay off the balance before the end of this period, you will not have to pay any interest, and if you carry a balance at the end, you will have to pay a high-interest charge due to the variable APR. In contrast, a debt consolidation debt is an unsecured personal loan that you must pay in regular monthly installments. It is a fixed monthly payment over a fixed tenure and could range anywhere from one year to seven years. The interest rate will depend on your credit history.
Rate of interest
The most important factor to consider is the interest rate. When you opt for a balance transfer credit card, you can enjoy the introductory offer, but if you do not repay within this duration, there will be higher interest rates. The key consideration is the period for which 0% interest lasts. Consider the payment you will need to make to repay the loan within the introductory period. A balance transfer can be good if you can make regular monthly payments. If not, choose a loan.
With a consolidation line of credit, there is no such thing as an interest-free period. You can find the right lender if you have a good credit score and enjoy a single-digit interest rate. There will be a fixed interest rate and a fixed monthly payment. This will give you a higher chance of repaying the debt. The interest rate will depend on the loan type and credit score. With a high credit score, you enjoy a low-interest rate.
Cost
Credit card companies have a balance transfer fee based on the total debt. It is important to factor in this cost before you make a decision. A balance transfer can cost somewhere around 3% of the amount transferred. With a higher amount, there is a higher fee to pay. In the case of debt consolidation loans, a loan origination fee is taken out of the total amount you borrow. The fee could go as high as 7 percent of the loan amount. However, you can find credit unions that do not charge any origination fee on loan. No matter what you choose, be aware of the fees and ensure that you are benefitting by paying the fees. You must also check the prepayment penalty applied by companies in case you pay your debt on time.
Loan terms
With a fixed term and fixed interest rate, a debt consolidation loan will help you with budgeting, but if you are not managing the credit card well, you could ultimately pay more for a longer period than you planned. A balance transfer credit card offers higher flexibility than a loan. Since there is a fixed payment in a loan, you are stuck with it, but balance transfer offers come with some flexibility. There is no ideal situation here. You need to choose what makes the most sense. If you have a stable income and enjoy fixed payments, a debt consolidation loan is a great option and if you like flexibility, consider the balance transfer credit card. Ultimately it is all about working on a repayment strategy that aligns with your needs.
Credit score
When you open a credit card and transfer your balances on it, you will see a push on the credit utilization ratio, and it will have a negative impact on your credit score. Even credit scoring models have a negative emphasis on revolving debt, and if you often transfer debt from one card to the other, you will see the score drop.
But once you pay down the balance, the score also will rebound. In contrast, a debt consolidation loan will help boost the credit score because your credit utilization ratio for the accounts will go to zero after the balances have been paid off.
Credit requirements
Lenders offer ideal terms and rates to those with excellent credit, whether you opt for a balance transfer credit card or a debt consolidation loan. If you have a low credit score, it is unlikely that you will get a balance transfer credit card that you qualify for. In that case, you could find a secured credit card, but they might not have the 0 percent APR offer. You can also qualify for a loan with poor credit but will have a higher interest rate. Remember to check your credit score and see how it affects your rates before you make a decision.
Loan repayment
Balance transfer credit cards will require you to be committed and disciplined in paying off the debt. The card issuer might ask you to make the minimum payments, which might not be adequate to eliminate the entire balance in the introductory period. Debt consolidation loans have a specific monthly payment for a fixed tenure, making it convenient to budget for the payments.
Savings on interest
If you can pay off the balance transfer under a limited time period, you will be able to minimize the interest amount you pay, whereas, in debt consolidation, the money you save depends on the repayment terms and the interest rate.
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- TurboDebt has a Trustpilot rating of 5/5 based on 1288 reviews
- Subject to qualification and approval. $1,500 monthly income required.
- Apply in 5 minutes. If you qualify, chat online with a friendly online debt representative.
The bottom line
Whatever your choice, it is important to have financial discipline and stop using credit cards as you pay off the debt. If you only have credit card debt, a balance transfer is a good deal but if you have a larger debt to pay off and spread across different loans, consider debt consolidation. It is important to commit to a debt management plan that will help you from falling back into debt. Compare both options and understand how each works for you. Choosing the right option based on your situation will help save money and make debt repayment easier.
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Writer
Vandita Jadeja is a financial writer and editorial assistant at Joywallet. She loves to read and write about money and brings 7 years of experience from the financial industry. She loves coffee, mountains and sunsets.
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