It’s not unusual to carry credit card debt from time to time. But most of us know that paying off this debt, especially if it’s high-interest debt, is a good move. After all, reducing or getting rid of your credit card debt not only helps you save money (and reduces the stress of carrying debt), but it can also increase your credit score, which can help you get better loan terms in the future.
Two popular ways to pay down or pay off credit card debt are with a debt consolidation loan or balance transfer credit card. But which is better?
We’ll give you the advantages and disadvantages of both a debt consolidation loan and balance transfer credit card and clue you in on when either choice might be a better option. Then you can decide the best way to reduce or pay off your credit card debt.
Balance Transfer Credit Card vs. Debt Consolidation Loan: Main Differences
First, let’s talk about balance transfers and debt consolidation loans:
- Balance transfer: A balance transfer is the process of moving high-interest credit card debt to a low- or no-interest card in order to consolidate debt and save money on interest charges.
- Debt consolidation loan: A debt consolidation loan is an unsecured personal loan that you use to consolidate debt at a lower interest rate. Unsecured means you don’t have to put up any collateral.
Now, let’s compare the two at a glance. Here are some of the main differences between a balance transfer and a debt consolidation loan:
|Balance Transfer Credit Card||Debt Consolidation Loan|
|Loan Amount/Credit Limit||Your credit history influences your credit limit, which can range from $300 – $15,000 or higher||$1,000 – $100,000. Average loan amount is $17,064|
|APR Range and Repayment Term||Variable introductory rates can start at 0% for 6 – 24 months. After the intro period, APR averages start around 12%||Average fixed rate starts around 10% for a 36-month term|
|Approval Requirements||Varies by card but can be influenced by your credit history and even the economy||Based on creditworthiness but generally a minimum DTI of 36% and 660 minimum credit score|
|Fees||Balance transfer fee: 2% – 5% of the balance with a minimum fee of about $5||Origination fee: 1% – 8% of the amount you borrow|
|When it makes the most sense (we’ll expand on this below)||Smaller amounts you can pay off during the introductory period||Amounts that will take you a while to pay off|
Is a Balance Transfer or Debt Consolidation Loan Better?
The big question: Is it better to consolidate debt with a balance transfer credit card or a debt consolidation loan (personal loan)?
Each one is better in different circumstances. Whether one is better for you will depend on your financial situation, the amount of debt you have and how long you need to pay it off.
When is a balance transfer better?
In general, a credit card balance transfer is good if you expect to be able to pay off your balance within a few months to a year while the introductory rate still applies.
Most low-interest or no-interest credit cards have an introductory rate, also referred to as a teaser rate. This special annual percentage rate (APR) is generally only available within the first few months to 2 years of getting the card.
After the introductory period (or promotional period), the interest rate will revert to a higher rate. Average credit card rate ranges start around 12%, but some cards have interest rates up to 23.99% and higher.
So, if it’s going to take you longer than the introductory period to pay off your balance, you might be better off paying down your debt in a different way.
When is a debt consolidation loan better?
A debt consolidation loan tends to be better for debt consolidation if you have a large debt that will take a number of years to finish paying off.
For instance, let’s say you’ve racked up $6,000 in high-interest debt that you’ve transferred to a credit card with a 0% APR for 6 months. You manage to pay $1,000 of your balance in the first 6 months and now have a balance of $5,000, which you calculate will take you 3 years to pay off. But that 0% APR changed to an 18% APR.
Meanwhile, you’ve found a personal loan with a fixed interest rate of 7% and 3 years to pay it off. In this scenario, you’d save over $2,000 in interest over the same period of time by going with the personal loan over the balance transfer credit card.
Balance Transfers: Pros and Cons
Like many things in life, evaluating whether something is worthwhile or suitable for you involves making a pro/con list. Well, we’ve done that for you! Here are some of the main benefits and drawbacks of a balance transfer credit card:
PROS Pros of Balance Transfers👍
Credit cards sometimes have 0% APR offers on balance transfers. This means you won’t pay a penny of interest through the course of the promo period.
Since you’re not paying any interest, all your monthly payments go toward reducing your principal balance. This means you could pay off your balance quickly.
Some balance transfer credit cards offer rewards/cash back on purchases. So, while you’re paying off your balance, anything new you purchase can earn reward points.
If you make your monthly payments on time, you can improve your credit score. Additionally, opening a new credit card without closing out the old ones can lower your credit utilization ratio (which is how much of your available credit you’re using). This is also good for your credit.
CONS Cons of Balance Transfers👎
The main disadvantage of a credit card balance transfer is that the low introductory interest rate usually reverts to a higher rate after 6 – 24 months. So credit card debt that remains after your introductory offer ends will begin accruing interest at a higher variable APR.
Usually, you’ll pay a balance transfer fee of up to 5% of the transferred amount. Some cards also have an annual fee.
While transferring your credit card debt is great, you may still have to solve the issues that led to the problems managing your debt in the first place.
Debt Consolidation Loans: Pros and Cons
A debt consolidation loan has its own benefits and drawbacks. Here are some common pros and cons of debt consolidation loans (personal loans):
PROS Pros of Debt Consolidation Loans👍
With a fixed rate, your monthly payments will be predictable and easier to budget for.
Depending on the lender, you can typically get a personal loan with a repayment term that’s 2 – 7 years, giving you lots of time to pay off the loan.
If you have other debt besides credit card debt, such as medical bills or student loans, you can use your personal loan to pay them all off.
Paying off your credit card debt and making all your monthly loan payments on time will help boost your credit score.
CONS Cons of Debt Consolidation Loans👎
With excellent credit, you may be able to get a low interest rate, possibly between 5% and 9%, but it won’t be as low as a 0% APR credit card.
You’ll typically be charged an origination fee for the loan, which can range from 1% to 8% of the loan amount.
Even though you’ll typically have longer to pay off your loan, having a loan to pay off can make it necessary to pause other financial goals like buying a house.
Still have questions? Here are answers to the most common questions about balance transfers and debt consolidation loans:
FAQ: Frequently Asked Questions
A balance transfer can influence your credit score for the better if you stay on top of your payments. The faster you pay off your balance, the faster you’ll see your credit score improve.
Keeping older cards open while not having a balance on them will help preserve the length of your credit history, a factor in determining your FICO® credit score. And getting the new card will also help reduce your credit utilization ratio, especially if the new credit card has a large credit limit.
The answer to this question is that it depends. But in general, a debt consolidation loan can help your credit quite a bit. Having an installment loan where you make your monthly payments on time is great for your payment history, which is the largest factor that goes into your credit score. And having the loan contributes to having a variety of types of debt (installment loans and revolving credit) that creditors generally like to see.
No matter what kind of loan you have, the amount you owe in relation to your income is important to lenders. Showing a low debt-to-income (DTI) ratio will be favorable to mortgage lenders. Having a credit card balance of $500 probably won’t have much influence on your DTI ratio. But a debt consolidation loan balance of $20,000 will be more significant.
In general, mortgage lenders want to know that you’re creditworthy – that is, you’re a good risk for paying back your mortgage. A history of on-time monthly payments will give you a gold star in this area, especially if those on-time payments are recent.
Many lenders offer personal loans. Your best bet is to shop around for the best rate and most favorable terms. You can start by contacting your local credit union or community bank or searching for online lenders.
Many of these same lenders might also have a balance transfer credit card to offer you and can advise which option might be more suitable for your situation.
In a word: yes. However, your interest rate will likely be higher than if you had good credit or excellent credit. And a credit card with an introductory 0% APR may not be likely. In general, the better your credit, the lower interest rate and better loan or credit card terms you’ll get.
Again, shopping around for the best rates will help you find the best solution for you. And seeking out a credit counselor near you can help you determine the best way to pay down your debt.
Make Paying Off Debt Easier
Both a balance transfer and a debt consolidation loan can be great options for helping you pay down your debt and increase your credit score. But be sure to explore other options like a home equity loan or home equity line of credit (HELOC). Which debt consolidation option is best for you will depend on your individual circumstances.
Experian™. “The Average Personal Loan Balance Rose 3.7% in 2021.” Retrieved June 2022 from https://www.experian.com/blogs/ask-experian/research/personal-loan-study/
National Credit Union Administration. “Credit Union and Bank Rates 2022 Q3.” Retrieved June 2022 from https://www.ncua.gov/analysis/cuso-economic-data/credit-union-bank-rates/credit-union-and-bank-rates-2022-q3