It is never easy to pay off debt, but your load can be lightened when you have smaller payments and a lower interest rate.
With common debts like personal loans and credit cards, two ways that you are able to lower your rate is by debt consolidation loans and balance transfers.
So, what is the difference between these two and which one is the best route to go down? Both debt consolidation loans and balance transfers have advantages and disadvantages, so you will need to make an informed decision and understand the fees, your debt and everything else before you dive into one of these options.
Let’s take a closer look at both of these options.
Balance Transfers with Credit Cards
A credit card balance transfer is where you transfer your debt to an existing or new credit card. This can be an attractive option if you know that you are able to pay your debt off quickly.
The idea is to move the debt to a card that has a lower interest rate or what would be better is it offers a 0% interest rate on your debt for a certain amount of time. When you are able to eliminate the interest, your loan balance will stop growing and every cent of every payment that you make goes directly to reducing your debt. However, you must read the fine print.
You will need to find out if you will need to pay a fee to transfer balances. These costs can be a percentage of the amount that you transfer or they might charge you a flat rate which can be more. Any savings that you are able to make with a lower interest rate need to more than cover any transfer fee. Also, if you open a new credit card, you might be also taking on a new annual fee.
When it comes to interest rate those that have good credit will be offered the best interest rates. If you see tempting offers then you will need to do your research and see what the card issuer will actually offer you once they have reviewed your credit. If you find a 0% APR card then you need to check the small print and find out how long the offer lasts. You need to check when the rate will change and what happens once the promotional period ends.
Balance transfers can be tricky because they are not really bad for your credit, but they can cause problems. This is because every time you apply for a new card, lenders will look at your credit history and any enquiry will put a dent in your credit. Your credit score can also be lowered by having too many consumer accounts like credit cards open. If you are going to use a credit card to transfer balances then you need to make sure that you use it as a debt pay off tool and not a way to increase your debt. You need to avoid using the card that you have paid off as this will just drive you deeper into debt.
So…what about debt consolidation? Keep reading to find out more…
Using Debt Consolidation
An alternative option to using credit cards is to use a personal loan for debt consolidation. If you are able to get a large enough loan then you may be able to combine several loans into one so that everything is one place. Debt consolidation loans usually come with a fixed interest rate, which can make more sense when credit card promotional periods are too short for you to pay back all the debt.
You may pay upfront fees for debt consolidation, but you also may not. There are some loans where the costs are obvious and include things like processing or origination fees. With other loans, the costs may seem invisible but these are actually built into the interest rate.
You will then need to compare multiple loan offers so that you can find a combination of fees and interest charges that will benefit you.
When it comes to the interest rate charged on a debt consolidation loan it will depend on the type of loan that you use. A personal loan that is unsecured will have a higher interest rate than a secured loan, for instance. However, you will still most likely pay an interest rate that is lower than your credit card.
If you believe that your debt will take several years to pay off then you will probably benefit from a debt consolidation loan. You will find both variable and fixed interest rates for these loans. Fixed rates make it easier for you to plan and budget as you will know exactly what your monthly payments will be for the term of the loan.
New loans also create enquiries like credit cards, which can then impact your credit score in the short term. In the long term though some debt consolidation loans could be better for your credit then balance transfers.
Generally, your credit score will be higher when you have a mixture of different types of credit and instalment loans as you look more attractive than a borrower who relies mainly on credit cards. If you are a heavy credit card user then it may appear that you are spending beyond your means and this is not sustainable.
Taking a debt consolidation loan can show that you have made a commitment to paying down your debt and that you have used the right type of debt for that purpose, which translates into you being a savvy borrower, that can show that you are likely to repay other loans in the future. Your credit will strengthen when you make payments on time and only take on debts that you are able to afford.
You might be wondering about how collateral works…
What About Collateral
There are some debt consolidation loans where you will need to pledge collateral, which means you give the bank or lender permission to take your assets and sell them if you fail to repay the loan.
Pledging collateral can help you to get approved, but it is also risky. If things don’t go to plan you could lose your home or your car. You should keep unsecured loans, unsecured as you will only be risking your credit.
If you use a home equity loan, for instance, to pay off an unsecured credit card debt, your risk dramatically increases, because if something you hadn’t planned on happens then you could lose your home.
If you already have debt that is secured by collateral, you can consider refinancing these loans separately. You can use a balance transfer or debt consolidation for unsecured debts and get a different loan for your secured debts. However, you are able to turn your secured debts into unsecured debts by paying off your secured debts with an unsecured loan, for instance, which will reduce your risk, but you need to make sure that it is worth any additional costs.
Using a balance transfer can work if you are able to pay off your debt quickly, but a debt consolidation loan will make more sense if you believe that it will take you years to pay off your debt. With both of these, you will be moving all your debt into one so that you have one monthly repayment to make and only one interest rate to manage, which can help with your cash flow. You just need to avoid creating more debt so that you can become debt free.