Your credit card debt has gotten out of hand and you’re not sure how you are going to be able pay it off. Consolidating your debt into one monthly payment is a good strategy.
As you consider the best way to consolidate your debt, your decision will likely come down to two commonly used debt consolidation vehicles - personal loans and balance transfer credit cards.
Both options can lower your monthly payments, reduce your interests and allow you time to pay your balances. Which is better? The answer depends on your specific circumstances.
In order to make a decision, you need to understand how each option can help you in eliminating your debt. in helping benefits of each option in eliminating your credit card debt.
Understanding Balance Transfers and Personal Loans
Personal loan – unsecured loan typically paid back to the lender with interest in fixed monthly payments over a set time period. An unsecured loan is based on the borrower’s creditworthiness and ability to repay the loan. You can consolidate your debt by using the funds from the personal loan to settle your outstanding credit card balances. Personal loans can be funded by a financial institution, such as a bank, or can be peer-to-peer, where you are connected to independent lenders to fund your request.
Balance transfer – credit card transaction transferring existing debt from one or more credit cards to a new card in order to take advantage of a 0% introductory APR offer for a specified period of time. To keep the introductory rate, you need to make minimum monthly payments by the due date. To maximize your savings, you should ensure you can pay your balance by the end of the 0% APR period. Otherwise, your interest rate will increase considerably. Balance transfer cards are issued by financial institutions including credit card companies, banks and credit unions.
Comparing Balance Transfers and Personal Loans
Before deciding between a balance transfer or personal loan, here are five things you should consider when comparing the two options:
When comparing credit cards and personal loans, the interest rate is the most important thing you should consider. While balance transfer cards offer a 0% introductory APR period, the interest rate will go up (current average APR is variable 17.65%) when the offer ends.
The rate you pay will depend on the type of loan you use. A personal unsecured loan will have a higher rate than a secured loan but your interest rate will still be lower than average credit card rates. The introductory credit card rates may be lower for a period of time. Personal loans have a fixed rate, which won’t change during the life of the loan. Interest rates for personal loans range from 4.99% to 35.99%. With good credit, you can find an interest rate in the single digits.
The deciding factor will be the amount of your debt and the length of the 0% APR period. If you can afford to pay off your debt before the introductory period ends, a balance transfer credit card may work for you. If not, you should consider a personal loan.
Personal loans give you more flexibility for the types of debt you can consolidate. Balance transfer cards may have restrictions on the type of debt you can transfer. Some balance transfer cards allow you to transfer other types of debt including student loans, car loans, mortgage, home equity loans or other monthly installment payments. You will need to read the terms and conditions to confirm the types of debt accepted.
While balance transfer cards accept credit card debt, most will not allow you to transfer debt from a credit card with the same issuer or its affiliates.
Total Debt Amount
After you know the amount of debt you want to consolidate, you should figure out how much you can reasonably afford to pay each month. This will help you determine how long it will take to pay the debt off.
If you’re considering a balance transfer credit card, keep in mind your balance transfer is restricted by your credit limit. On the other hand, personal loans are available in amounts up to $100,000. With balance transfer credit card, it’s important to ensure you can pay off the debt before the 0% APR period expires. Otherwise, you will end up paying a much higher interest rate on the remaining balance.
The 0% introductory APR period is short compared to the length of a personal loan. While the longest no-interest offer currently available is 21 months, you can get a personal loan for 72 months or longer.
Your Credit Score
If you have good or excellent credit, you have a better chance of getting approved for a balance transfer credit card with a 0% APR period or a personal loan with a low interest rate.
To get the best balance transfer cards and personal loans, a credit score of 700 or above is recommended. Some balance transfer cards will approve your application is your score is a little lower. However, if your credit score is lower than 650, getting approved for either option will be difficult.
With a balance transfer card, you may see a great promotional offer but the card issuer takes your credit score into consideration and you might not get the advertised offer.
With personal loans, you could get approved but still not qualify for the lender’s best interest rates. In fact, you could be given a higher rate than what you’re paying on your credit cards, if your credit score is good but not excellent, you might be better off with a balance transfer card. Many personal loan companies let you prequalify for a loan with a soft credit check, which will not hurt your credit to see the interest rates you qualify for.
Even if you are approved for a balance transfer card, you still have to be approved for a credit limit high enough for all the debt you’re trying to consolidate. Your credit score will affect the credit limit offered.
When you are considering your options, don’t forget the fees as they may add costs beyond the balance transfer and loan offers you receive. Balance transfer cards usually charge you a balance transfer fee of 3 to 5 percent of the amount transferred, often with a minimum fee of $5 to $10. Make sure any savings from the 0% APR offer covers the transfer fee. There are a few balance transfer cards with no balance transfer fees but they require a high credit score.
Many lenders will charge an origination fee, a one-time charge taken out of the total loan amount. Origination fees can be as high as 6% of the total loan amount. Make sure to do your research as not all lenders charge these fees. Banks and credit unions generally do not charge origination fees while most online lenders do.
With both personal loans and balance transfer credit cards, a late payment fee may be imposed if you submit your payment after the due date or miss it completely. A balance transfer card may also charge a penalty APR (typically 30%) if you are over 60 days late. You can find some balance transfer cards which do not charge late fees or penalty APR.
The Bottom Line
Once you do your research and review your options, you should come to a conclusion as to which is the best option for your financial situation.
A balance transfer card might be the best option if
- You can repay the debt within a year, which is the average length of 0% APR offers.
- Your debt is under $10,000
A personal loan might be the best option if:
- You have debt other than credit card debt such as high-interest auto, home and student loans or medical bills.
- Need longer repayment time. If you can’t pay of a balance transfer credit card before the introductory period, the regular APR can be costly. APR on personal loans is generally lower and with loan terms up to five years, you have more time to pay off the debt at a reasonable monthly rate.
- Want to boost your credit score. Installment loans count more favorably than credit card debt in the FIOC credit score calculation.