Which Consolidation Method Is Better: A Personal Loan Or Balance Transfer
Consolidation is one of the front line debt management strategies; it allows several debts to be combined into a single monthly payment, usually under more favorable terms and conditions.
Debt consolidation is a fairly broad category, which encompasses several different types of debt vehicles and solutions. When done right, it can lead individuals to debt freedom and a brighter financial future.
Here we will discuss two popular methods of debt consolidation - personal loans and balance transfers. We will discuss the pros and cons of each and determine under what conditions one may be preferable to the other.
Why Consolidate Debt With A Personal Loan?
The general premise of debt consolidation with a personal loan is simple - the borrower takes out a personal loan which they then use to pay off all outstanding debts. This process leaves them with a single monthly payment making it easy to keep up with their debt obligations.
For those borrowers who are seeking to consolidate high-interest credit card debt, this method can be particularly advantageous because the interest rates carried by personal loans are typically much lower than those associated with credit cards.
Personal loans are considered unsecured debt, meaning the borrower is not required to pledge collateral to guarantee the debt. Because of this, the loan’s interest rate and other terms is a direct result of a borrower’s credit history.
- Lower Interest Rate: Depending on the applicant's credit score, an interest rate much lower than those carried by the average credit card can be achieved
- Ease Of Payment: Since all debts are combined into a single monthly payment, it makes it much easier for the borrower to stay up to date with their payments
- Lower Overall Cost: A lower interest rate will result in lower interest charges, meaning lower overall cost over the life of the debt
- Not Applicable For All Applicants: To take advantage of debt consolidation with a personal loan, the applicant's credit score must be good enough to receive a favorable interest rate, meaning not all applicants will qualify
- Fees: All loans come with origination fees, usually 2% - 5% of the total loan amount. Depending on this size of the debt being consolidated, these fees may make this strategy prohibitive
Why Consolidate Debt With A Balance Transfer?
Most credit card companies offer balance transfer promotions that grant the borrower 0% APR on all transferred balances for a period of 6 to 12 months.
For example, say an individual has two credit cards, one with a balance of $2300 and the other with no balance that includes a promotional rate period. If they transfer the balance of the first card to the second one, they will effectively pay no interest on the $2300 balance during the promotion. This allows real progress towards paying down the debt since all payments will be going to the principal balance.
- Interest-Free Period: a 6 - 12-month interest-free promotional period will result in major savings for the borrower and will allow them to aggressively pay down their debt
- Combines Payments: Because one or multiple balances are transferred to another card, the individual is effectively consolidating their credit card debt into a single payment
- Easier To Qualify: Far more applicants will find that they qualify for credit card transfer promotions than a personal loan. Typically speaking, credit card companies require a minimum score of 660 to approve a money transfer credit card
- Fees: While transferred balances will be exempt from interest charges for a good period, there are fees associated with these transfers, typically ranging from 3% - 5% of the total transferred balance
- Watch Out For Deferred Interest: Some balance transfers offer 0% deferred interest, meaning if the entire transferred balance is not paid off within the promotional period, the borrower will be retroactively charged interest on the total transferred balance
What Is The Better Consolidation Option?
Deciding between a balance transfer and a personal loan for debt consolidation depends on the situation of the borrower.
When Is A Personal Loan A Good Idea
- When the borrower has a good enough credit score to secure a low-interest rate
- When the borrower wants to merge several different outstanding debt balances into a single loan
- When the borrower wants to pay off their debt over a longer time frame
When Is A Balance Transfer A Good Option
- When the transferred balance can be paid off within the promotional time frame
- Savings derived from the 0% APR period outweigh the cost of the transfer fee
- If the borrower’s credit score doesn’t allow them to qualify for a personal loan with a favorable interest rate
Balance transfers and personal loans are both quality options for debt consolidation, and each comes with its own set of unique advantages and drawbacks. Regardless of which option a borrower chooses, it is important to stay diligent with payments, as failure to do so will inevitably continue the cycle of debt.