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Debt Consolidation or Balance Transfer?
By Quinlan Grim MONEY RESEARCH COLLECTIVE
If you’re looking for a way to pay off high-interest debt and improve your credit score, you have options. Debt consolidation loans and balance transfers are two methods to simplify your payments. While they have similar benefits, one of these options might be a better path for you to get out of debt.
This guide will take you through the differences between debt consolidation and balance transfer to help you decide which method is best for you.
Balance transfer credit card or debt consolidation: choosing the best option for you
A balance transfer credit card and a debt consolidation loan are two reliable debt management plans for someone with a lot of high-interest debt. Both methods require you to pay off your debt within a set period of time.
We’ll get into the pros and cons of each option below. But first, it’s important to understand that these debt management plans are not:
- Bankruptcy: You will still have to pay your debts in full. Personal loans and balance transfer credit cards can have some short-term impact on your credit score, but they aren’t as detrimental to your credit as bankruptcy.
- Debt settlement: Debt settlement is the process of negotiating a lower payment with your creditors. The options reviewed in this article are less harmful to your credit and still require you to pay the full amount of your debt.
Managing your debt does not mean absolving it. These methods are meant to help you get control of your debt and repay it in a reasonable amount of time. There are a few key differences between a debt consolidation personal loan and a balance transfer, but both methods may work for someone with the following:
- High-interest debt to multiple creditors
- A good credit score
- A stable income source
- The ability to make regular payments
What is a debt consolidation loan?
A debt consolidation loan is an unsecured personal loan used to pay your debts. When you get a debt consolidation loan, you combine all your high-interest debt. That way, you can make a single monthly payment, reduce the risk of accruing interest and pay off your debt faster.
Most debt consolidation programs are reserved for people with good credit scores — at least 600, but some debt consolidation companies require a score of 670 or higher. Personal loans for debt consolidation come with a strict repayment schedule that spans 2-7 years. Your interest rate and time frame for repayment will depend on your credit history, the amount of debt you have and your current income.
The pros
- Fixed interest rates: Your personal loan will have the same interest rate throughout your repayment period, with no extra fees unless you fall behind on your payments.
- Simplified payment schedule: You can set up autopay to make one monthly payment instead of several.
- Consolidates multiple types of debt: A debt consolidation loan can combine multiple types of debt, including medical bills and credit cards.
- Up to $100,000 in consolidation: Depending on your loan, you may be able to borrow as much as $100,000 and pay it off over 7 years.
The cons
- High annual percentage rate (APR) without good credit: It’s possible to get a debt consolidation loan even if you have bad credit. However, your loan will probably have a high APR — maybe even higher than your original debt.
- Origination fees: Some lenders charge as much as 8% of the loan amount as an origination fee.
- Interest charges apply from the beginning: Unlike a balance transfer, you’ll have to pay interest on your loan throughout the repayment period.
The credit limits and requirements
Most personal debt consolidation loans have strict credit requirements. Some lenders may only approve you if you have a credit score of 670 or higher. That’s because these are unsecured loans — unlike a secured loan, your personal loan is not backed by collateral, so the lender will want assurance that you can pay it back on time.
Some of the best debt consolidation loans have options for people with “fair” credit (between 580 and 669), but you should expect a higher APR. If the APR offered by your loan is higher than your current debt, it might not be worth it.
The impact it has on credit scores
Debt consolidation will improve your credit score in the long run. Once you pay off your loan, you’ll see a boost in your score.
However, it can have some short-term negative impact on your credit. Your lender will run a credit check to approve your loan, which can hurt your score. The personal loan will also show up as a new account on your credit report. New credit can temporarily lower your score until you have a history of on-time payments.
Despite those impacts, a debt consolidation loan might be worth it for the long-term benefits. If you’re debating between debt consolidation and bankruptcy, consolidation is the better choice for your financial future if attainable.
What is a balance transfer credit card?
A balance transfer credit card transfers all your credit card debt onto one card. These cards usually come with a 12 to 21-month promotional period. Within that time, they have 0% APR.
If you can pay off your credit card debt within that introductory period, you’ll save a lot in interest. But if you can’t pay off your balance within that time, you’ll experience interest hikes. Balance transfers are best for someone who owes to multiple card issuers and wants to pay it off quickly.
The pros
- No interest in the first months: Your credit card issuer might offer a promotional period of up to 21 months. If you can pay off your credit card balance within that period, you won’t have to pay any interest.
- A faster path out of debt: Paying off your balance within the promotional period is a quick way to get out of debt. You’ll spend more money upfront but save a lot on interest charges.
The cons
- High APR after the promotional period: If you still carry a balance after the promotional period ends, you’ll be charged the card’s standard APR, which could be higher than your original card’s rates.
- Balance transfer fees: Some card issuers charge a balance transfer fee or card origination fee of up to 5% of your balance.
- Can have low balance limits: Depending on your credit score, your card might have a lower credit limit than the amount you want to transfer. Most credit card issuers don’t tell you the balance limit until they approve you for the card.
The credit limits and requirements
Like a personal loan, balance transfer requires a high credit score. You’ll get the best rates with a credit rating of “very good” or “exceptional” (above 740). With a lower score, you’ll most likely have a higher APR after the promotional period ends.
Your credit score can also affect the balance limit on your card. Depending on your limit, you may be unable to transfer your entire credit card balance to your new card.
The impact it has on credit scores
A balance transfer can impact your credit score at the outset. Like with a personal loan, your score can take a hit when you apply for a balance transfer credit card. These cards can also affect your credit utilization ratio or the amount you owe in relation to your card limit.
For example, if you transfer your balance of $50,000 to a card with a $50,000 limit, your credit utilization ratio will be 100%. That can lower your credit score until the balance is paid off. On top of that, credit bureaus often dock points for revolving debt or debt transferred from one account to another.
On the other hand, a balance transfer credit card can help you pay off your debt faster than a personal loan. Repaying your debt is the best way to improve your credit. The impact of a balance transfer might be harsher upfront, but you’ll be on track to boost your score faster than with debt consolidation.
How do you determine which you need?
If you’re deciding between a balance transfer or a debt consolidation loan, there are a few factors you’ll want to consider. The best option for you depends on your credit history, type of debt, income and more.
Check the interest rates
A debt management plan can only help you save money if it has lower interest rates than your current debt. Compare the potential interest rates before you make your choice.
If you’re looking for a debt consolidation loan, you can compare quick pre-approval offers online. Most lenders provide online offers with estimates for your interest rate, loan amount and repayment time frame. Pre-approval doesn’t require a hard credit check and won’t hurt your credit score. You can consult a debt consolidation lawyer about the best option if you have fair or poor credit.
If you’re shopping for the best balance transfer credit card, compare potential interest rates online before you apply. These cards have the advantage of interest-free promotional periods but might have above-average APR once that period ends.
Be aware of any consolidation or balance transfer fees
Pay attention to the fees that come with every offer. Personal loans often charge an origination fee, which is subtracted from the total loan amount. For example, if you’re approved for a loan of $5,000 but have an origination fee of 5%, only $4,750 will actually go toward your debt.
Balance transfer credit cards also come with fees. You may be charged between 3% and 5% of your balance when you transfer it to the new card. Be sure to ask your lender or credit card issuer about any potential fees before you apply.
Know how much debt you have
The amount of debt you have is a crucial factor in choosing the right repayment plan. Consider your debt-to-income ratio. If you can repay your credit card debt in less than a year, a balance transfer might be the best solution. You’ll save on interest rates and pay your full balance faster.
However, you might want to consider debt consolidation if you have multiple types of debt that could take years to pay off. A personal loan offers simple, structured payments to fit your income. You’ll pay a flat interest rate throughout the course of your repayment.
Look at repayment plan options
Whether you’re interested in a balance transfer or personal loan for debt consolidation, be sure to do your research. Look into pre-approval offers from multiple lenders. Your lender or credit card issuer should have positive customer reviews and plenty of third-party ratings.
Be aware of scams — you should never have to pay an upfront fee for debt consolidation. You may be charged fees as a percentage of the amount loaned, but not until you’ve been approved. The best lenders will explain all fees and interest rates before you agree to your loan.
Get out of debt with debt consolidation or balance transfer
Balance transfers and debt consolidation loans are simple, effective solutions to get out of debt. Either option will simplify your payments and help improve your credit in the long run.
If you choose a debt consolidation loan, you can pay off multiple types of debt within a few years. With a balance transfer credit card, you may be able to pay off your credit card debt interest-free in under a year.
Whichever solution is right for you, be sure to stick to your payment schedule. Simplified payments will help you save money, get control of your debt and boost your credit score faster.