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Debt Consolidation or Credit Card Refinance?
By Peter Burns MONEY RESEARCH COLLECTIVE
Debt can be difficult to manage. When multiple bills come in each month with different interest rates and fees, it can cause a lot of stress. Two popular strategies for controlling your debt are debt consolidation and credit card refinancing. This article breaks down the similarities and differences between these two options so you can understand if one is a good idea for your financial situation.
Credit card refinancing vs. debt consolidation
If you’ve struggled to pay off debt and tried negotiating with debt collectors without any luck, you may want to try a new strategy. Credit card refinancing and debt consolidation are debt repayment plans that help you simplify your payments. Here, we’ll look at each option, including the pros and cons.
What is debt consolidation?
Debt consolidation is the process of taking out a debt consolidation loan to roll one or more types of debt together into a single loan. By consolidating debt, you can make monthly payments to a single source with a fixed interest rate — meaning the rate won’t change.
How debt consolidation works
When you have multiple sources of debt or debt at high-interest rates, you can use debt consolidation to help you improve your finances. To use this strategy, you will want to take out a loan with a lower interest rate than you currently pay. Some types of debt that a debt consolidation loan can pay off include:
- Credit card debt
- Student loan debt
- High-interest personal loan debt
The two types of debt consolidation loans available are secured and unsecured loans. Secured loans are guaranteed with an asset as collateral. For example, a home equity loan is secured because your house is used as collateral and can be taken if you cannot make your loan payments. Unsecured loans are not dependent on collateral, making them harder to get. They often come with higher interest rates than secured loans.
By reorganizing your debt through debt consolidation, you will need to pay one loan each month instead of several sources of debt. There are different types of loans and lenders available. Be sure to shop around to find the best debt consolidation loans for your situation before agreeing to any terms.
The advantages
Using debt consolidation to pay off what you owe comes with some benefits. If your loan’s interest rate is lower than the rate of your previous debts, debt consolidation may be a good idea because you’ll pay less overall. A fixed-rate will also make every monthly payment predictable and easier to budget.
Another advantage is that you’ll only have to make one payment each month. So instead of dealing with multiple bills with different amounts and due dates, you’ll have all your debts in one convenient place.
The disadvantages
Although debt consolidation can help you get out of debt, it has some drawbacks. It’s convenient if you want to pay off all your loans in one place, but it doesn’t solve your debt problem. If you have a problem with spending more than you can manage, debt consolidation is likely not a solution that will improve your habits in the future.
There’s also a chance you’ll end up paying more through debt consolidation than you would without it. If your loan has a higher interest rate but a lower monthly minimum payment, you may feel more financially stable each month but will pay more in interest overall.
Finally, taking out a debt consolidation loan is risky in the same way as any personal loan. If you take out a secured loan, you may risk losing your property if you cannot make payments. Taking out another loan may also affect your credit score.
What is credit card refinancing?
Even using the best credit cards, you can still rack up debt quickly. Credit card refinancing allows you to get more favorable terms on your existing loan. You may have a period with a lower or even no interest rate. The goal is to pay less interest overall to pay off your credit card debt faster. There are a few options, including a balance transfer credit card or personal loan.
What is a balance transfer card?
A balance transfer credit card allows you to move your debt from other credit cards to this card up to the agreed-upon credit limit. In most cases, they offer you an introductory period of 0% interest or a low interest rate that usually lasts between 12 and 18 months but can last longer. Once the initial limit has expired, interest rates will increase, and you will need to pay off your remaining debt as your balance gains interest at a higher rate.
How credit card refinancing works
If you want a balance transfer credit card, you must choose the best one for you and apply. Once the credit card company has approved your balance transfer card application, you can transfer other credit card debt to your new card up to the credit limit. Some issuers allow free transfers, but many will charge a balance transfer fee of 3% to 5% of the transferred total.
Suppose your total credit card debt exceeds your balance transfer card’s limit. In this case, you will need to decide which debt to transfer. You should prioritize accounts with the highest interest rate.
Another option is to use a personal loan to refinance your credit card debt. This may be a good option for those who need a longer time to pay off the debt and have a good credit score. The interest rate on a personal loan will be lower than a credit card’s rate. However, you may have to pay an origination fee.
The advantages
Like debt consolidation, having all your credit card debts reorganized into one single monthly payment is very convenient. However, the main advantage of credit card refinancing is the introductory period of the balance transfer card. During this introductory period, you may not have to pay any debt interest. Without interest, your payments will only go towards paying down the principal, which is an excellent opportunity to repay your loans in full.
If you choose to take out a personal loan, you could get a lower interest rate and reduce your monthly payments.
The disadvantages
Credit card refinancing comes with some negative aspects. While the introductory period presents an excellent opportunity to repay your loans, it doesn’t last forever. Your variable interest rate after that can be costly if you cannot pay the entire balance during the introductory period.
Depending on your credit score, it may be challenging to attain a balance transfer card or get a card with the deal you want. Issuers often require a credit score of 670 or higher to be eligible. The better your credit score, the better your interest rate will be after your introductory period. You may want to improve your credit score before applying for a card.
Late or missed payments may receive penalty annual percentage rates (APR) much higher than an ordinary APR. A late or missed payment may also disqualify you from the introductory period, and you may be charged high interest for monthly payments.
Refinancing with a personal loan also has some downsides, including being hard to qualify for with a low credit score. Even though you may lower your interest rate and monthly payments, it could mean paying more in interest over time since you’re taking longer to pay the debt back. Plus, you may have to pay an origination fee.
The most notable differences
Although debt consolidation and credit card refinancing are similar in many ways, there are some differences. A significant difference is what you are trying to accomplish. Debt consolidation or refinancing with a personal loan is a good choice if you want more stability while you pay off your debt. On the other hand, credit card refinancing with a balance transfer credit card can be effective if you can pay off your credit card debt quickly.
The interest rates
Debt consolidation and credit card refinancing have different interest rates. Debt consolidation offers a fixed rate. Credit card refinancing with a balance transfer credit card has a variable interest rate that begins at 0% or very low during the introductory period and will rise afterward to a high-interest rate.
To maximize any of the options, the best action you can take is to improve your credit score as much as possible before taking any other action. Be sure to pay your bills on time, keep an eye on your credit score, remove charge-offs and eliminate collections from your credit report if possible. A higher credit score will allow for lower interest rates for both debt strategies.
The borrowing amount
The size of your debt consolidation loan will depend on what the issuer is comfortable giving you and the amount of your debt. Depending on the lender, they can range anywhere from $1,000 to $100,000. Transferring your credit card debt to a balance transfer card will depend on how much overall debt you have and the credit limit that the issuer has approved.
The repayment period
Debt consolidation companies offer a fixed repayment period for debt consolidation loans. Some lenders offer multiple options, while others may only offer two options, like a three or five-year loan.
The repayment period with a balance transfer card depends on how quickly you pay off the principal debt. Balance transfer cards have different introductory periods. After that period expires, your card will function as a normal credit card. You will need to make monthly payments until the debt is gone.
Is a personal loan a good substitute for a debt consolidation loan?
A debt consolidation loan is a type of personal loan used to pay down several debts and reorganize them into one place. Technically, there isn’t any difference between a debt consolidation loan and a personal loan except for its use. A personal loan can be used for debt consolidation but can also be used to finance other things, including:
- Weddings
- Home improvements
- Medical bills
- Car maintenance
- Large purchases
Which is better: debt consolidation or credit card refinancing?
Both debt consolidation and credit card refinancing offer ways to control your debt by restructuring your debts into a single payment. Debt consolidation offers a fixed interest and term limit but may cost you more overall, depending on the interest rate. Credit card refinancing with a balance transfer credit card allows you an introductory period of time where the interest rate may be as low as 0%. But the rate will rise much higher after that period expires. There are other ways to refinance your credit card debt as well, including with a personal loan that has a fixed interest rate.
Choosing debt consolidation or credit card refinancing depends on your financial situation and how you want to approach the problem. Both options are not solutions to make your debt disappear, but they can serve as strategies to help you get there.