Balance Transfer or Personal Loan - Choose Wisely in 2023!

What's a Debt Consolidation With a Personal Loan, and When to Choose?

Debt Consolidation With Personal Loans: An Overview

Debt consolidation with a personal loan is a financial strategy that involves taking out a new loan to pay off multiple high-interest debts, such as credit card balances, medical bills, or other outstanding loans. Consolidating your loan payments into a single monthly payment with a fixed interest rate and loan term helps streamline your repayment schedule. Personal loans can range from 12 to 60 months and usually offer interest rates between 6% and 36%.

The personal loan is typically unsecured, meaning it does not require collateral, and has a fixed interest rate and repayment term (There are also secured loans). After the lender approves your application, you can receive your funds and only have to pay the lender every month. Then the lender is responsible for distributing your monthly payment to all your creditors.

Debt Consolidation With a Personal Loan Might Be a Suitable Option if You:

• Need a longer repayment period to pay off your debts, up to several years.
• Want the security of a fixed interest.
• Seek a fixed repayment schedule: A fixed schedule will give you a clear notion of when your debt can be paid off, unlike revolving credit lines of credit cards.
• Prefer predictable monthly payments:Using a personal loan to consolidate your debt can turn multiple monthly payments into a single one, which helps you draw up your budget and repayment schedule.
• Struggle with overspending on credit cards and need to eliminate the temptation.
• Have multiple high-interest debts: You can reduce your interest costs and streamline your repayment schedule by consolidating many high-interest loans or credit card bills into a single personal loan with a lower interest rate.

What's a Balance Transfer Credit Card, and When to Choose?

Debt Consolidation With a Balance Transfer Credit Card: An Overview

Typically, you must apply for a new credit card to complete a credit card balance transfer to consolidate debt. This credit card offers a balance transfer offer, usually a promotional 0% Annual Percentage Percentage (APR) for a limited term (12 to 21 months).

Once approved, you can transfer existing credit card balances onto the new card, consolidating multiple debts into a single payment. During the introductory period, interest will not accrue on the transferred balance, allowing you to pay the principal amount faster.

However, your balance transfer provider will charge a service fee for adding it to your balance, usually 3% to 5% of the transfer amount. Additionally, if you cannot pay off the transferred balance before the end of the promotional period, the interest rate will increase to the regular APR, which can be high.

When Is a Balance Transfer the Best Option?

Smaller debt amounts: Balance transfers are ideal if your debt is relatively small and you're confident you can pay it off entirely before the 0% introductory APR period ends.

Flexibility for new purchases: Many credit cards with balance transfer offers also have 0% introductory APR periods for new purchases. This provides flexibility if you need to make additional expenses while paying off your debt.

Avoiding reliance on multiple balance transfers: While it can help you in this emergency, it's not a good idea for your credit score in the long run. Also, it is not recommended to transfer your balance again at the end of the promotional period, although it is possible.

Now that we've discussed the two main options for debt consolidation let's take a closer look at some of the factors you should consider when deciding which approach is best for your situation.

Factors to Consider When Consolidating Your Debt

1. Interest Rates

When comparing debt consolidation options, interest rates are crucial to consider.

Although the Balance transfer credit card has an interest-free period, you may need to pay a higher interest rate than other loans afterward. Personal loans do not offer an interest-free period, but you can get lower interest rates thanks to credit cards.

Tip: Consider the length of the 0% interest period for balance transfer cards and whether you can pay off the debt during this period.

2. Fees

• Balance transfer cards often charge a one-time fee, usually 3% to 5% of the transferred amount.
• Personal loans also have some additional fees, such as a one-time fee deducted from the loan amount.
• Banks and credit unions typically don't charge origination fees on personal loans.

Tip: Compare the fees to ensure you don't pay unnecessary costs while securing favorable terms.

3. Repayment

Personal loans offer fixed interest rates and repayment periods, providing predictability and helping with budgeting. You'll have more options when paying off your balance transfer card. However, if your debt is not managed correctly, you could pay more in the long run.

Tip: Consider your financial situation and personal preferences when deciding.

4. Credit Score Impacts

Both balance transfer cards and personal loans can help improve your credit score when used responsibly.When you pay them back, it improves your credit score because it lowers your credit utilization ratio. Additionally, using different credit products increases your credit portfolio, which is also good for your credit score.

Tip: Both options may temporarily lower your credit score due to hard inquiries.

5. Qualification Criteria

Lenders offer the best rates and terms to individuals with good or excellent credit scores. A lower credit score makes obtaining a balance transfer card difficult, or the issuer may offer a higher interest rate on a debt consolidation loan.

6. Types of Debt

Debt consolidation loans are more versatile and can be used for personal and student loans. But you can usually only use a balance transfer card to pay off credit card debt.

Tip: Consider the types of debt you have when comparing these options.

7. Amount of Debt

Both balance transfer cards and personal loans have limits on the amount of debt you can consolidate.The approved loan amount is usually confirmed when you receive the loan offer. The loan amount may also not cover all debt, and it's best to get rid of the debt with the highest interest rate first.

Pros and Cons of Using a Personal Loan

Pros:

Lower interest rates: If you have a good credit score, you may get a personal loan with lower interest rates.

Fixed repayment schedule: Personal loans usually come with fixed repayment terms, providing a clear timeline for becoming debt-free and helping you to plan your finances more effectively.

Predictable monthly payments: If your loan offer has a fixed rate/APR and repayment term, you'll know how much you'll pay back each month. You can determine what expenses to set aside each month and create other financial plans.

Unsecured borrowing: Personal loans are typically unsecured, meaning you don't need to put up collateral such as your home or other assets. This can be beneficial if you're uncomfortable using your assets as security.

Flexibility: Personal loans have almost no usage restrictions. You can use it to consolidate debt, renovate your home, pay medical bills, and even finance a vacation or wedding.

Potential credit score improvement:If used responsibly, a personal loan can help improve your credit score by reducing your credit utilization ratio and demonstrating a history of on-time payments.

Cons:

Qualification requirements:Personal loans usually come with a credit check when a loan offer is made. You'd better have a good credit score and a steady income to get good loan terms. If you don't, you may be able to qualify or receive disadvantages.

Fees and charges: Some personal loans come with origination fees, prepayment penalties, or other charges, which can increase the overall cost of borrowing.

Borrowing more than you can afford: The flexibility of personal loans can make it easy for borrowers to overlook the cost and amount of borrowing. Sometimes, when borrowers cannot repay, they take out new loans to pay off old ones, leading to overborrowing and increased debt.

Long-term commitment: Depending on the loan term, you could make monthly payments for several years, impacting your financial flexibility.

Possibility of higher interest rates: For those with lower credit scores, the interest rates on personal loans may be higher than other forms of borrowing, such as home equity loans or lines of credit.

Debt trap risk: As discussed earlier, failure to pay off old loans with new loans can lead to a cycle of debt because the debt remains.

Pros and Cons of Using Credit Card Balance Transfers

Pros:

0% introductory APR:

Many balance transfer credit cards offer a 0% introductory annual percentage rate (APR) for a specified period, providing substantial savings on interest payments compared to higher-rate credit cards.

Flexibility in payments:

Balance transfer credit cards usually allow for flexible payments, enabling you to pay more than the minimum amount due each month, which can help you pay off your debt faster.

Interest-free grace period and Faster debt payoff:

A lower interest rate during the prime period is helpful. With it, you can pay off your debt faster by spending most of your repayments on reducing your principal balance rather than interest.

Additional benefits:

Balance transfer credit cards may come with additional perks, such as purchase protection, extended warranty coverage, or travel insurance, depending on the card issuer and specific card offer.

Easier budgeting:

Having just one credit card payment each month can streamline your budgeting process and help you focus on paying down the debt.

Potential credit score improvement:

Consolidating credit card debt can help avoid over-utilization of credit. Plus, you can improve your credit score through good behavior, such as consistently making on-time payments and reducing additional high-interest debt.

Cons:

Balance transfer fees: Most balance transfer credit cards charge a fee to transfer a balance, usually ranging from 3% to 5% of the transferred amount. These fees can add to the overall cost of moving your debt, offsetting some of the potential interest savings.

Limited-time offers:A low introductory price or 0% is not a permanent offer. The promotion period is usually 6 to 18 months. After this period, if you fail to pay off your entire balance within this period, you may be charged the card's standard interest rate on the remaining balance.

The temptation to spend: Credit cards may encourage additional spending, making it more challenging to pay off your debt. Having available credit after transferring a balance can lead to a higher overall debt load if not managed responsibly.

Limited transfer amounts: Your balance transfer will be limited to the card's credit limit, which may only cover part of your debt. This can make it difficult for borrowers with significant debt to fully consolidate their obligations using a single balance transfer credit card.

Eligibility and credit score impact:

A balance transfer is a credit product, so the issuer will do a hard check on your credit report, which can temporarily lower your credit score. Plus, it increases your credit utilization ratio, which is also a negative indicator of your credit score. Also, if you have bad credit, you may not get approved and offers.

Alternatives to Balance Transfer or Personal Loan for Debt Consolidation

If you're considering debt consolidation but are unsure whether a balance transfer or personal loan is the right choice, there are several alternative options to explore:

Debt Management Plans (DMPs):

Nonprofit credit counseling organizations can offer debt management plans, consolidating unsecured debts into a single monthly payment.When you contact them, they will negotiate lower interest rates and waive fees with your creditors. With their help, you don't need to contact lenders directly or apply for a new loan or credit card to manage your loans.

Loan Refinancing:

Instead of using a personal loan or balance transfer, you can refinance your existing debt with the same type of loan. With loan refinancing, you can take out a new loan to pay off your outstanding loan. This approach can help you get better terms, a lower interest rate, or a longer repayment period than your existing debt. For example, you can take out a new 8% personal loan to pay off a 10% student loan.

Negotiate with Creditors:

Contact your current creditors to discuss your financial situation and negotiate a more manageable payment plan or lower interest rate. Creditors may be open to negotiating, as they prefer to recover some of the owed amounts rather than risk you defaulting on the debt entirely.

Debt Snowball or Avalanche Methods:

The avalanche method has two principles: first, the balance with the highest APR is paid first; second, the balance is paid off from the highest APR to the lowest APR. This method causes you to pay less interest rate overall and is preferred by some financial experts. Moreover, you’d arrange your balances from the highest APR to the lowest.

If you're having trouble understanding this method, imagine a snowball rolling down a hill, starting small. It gets bigger; it also gets faster. This reveals the inner logic of the method: as you settle the largest debt balance, the overall "snowball of debt" will move toward paying off debt more quickly.

Increase Income and Reduce Expenses:

Consider taking on side gigs, freelancing, or part-time jobs to increase your income, and look for ways to cut expenses in your daily life. By generating additional income and reducing spending, you can allocate more funds toward debt repayment and potentially pay off your debt sooner.

FAQs About Balance Transfer or Personal Loan

Is It Possible to Use Both a Balance Transfer and a Personal Loan Simultaneously?

Yes, you can use a combination of both balance transfer credit cards and personal loans to manage your debt more effectively. This approach allows you to take advantage of the benefits of both options while mitigating their drawbacks.

For example, suppose the situation is as follows:

You have $30,000 of high-interest credit card debt,

You cannot pay off with a balance transfer credit card during the 0% introductory APR window.

Solution:

Transfer a manageable portion of your $17,000 debt to an introductory balance transfer credit card with a 0% APR.

For the remaining $13,000, you can apply for a personal loan with a lower APR.

Finally, you can pay off that portion with a credit card during the promotional period without accruing interest. You can also pay off your remaining balance at a lower interest rate and get a fixed rate and repayment schedule.

How Does Having a Loan or Credit Card Debt Impact Applying for a Mortgage?

When applying for a mortgage, having a mix of credit, including a personal loan and credit card debt, can improve your credit score.Take the FICO scoring model as an example; your credit mix accounts for 10% when calculating your credit score. Since a personal loan is not considered a revolving form of credit, transferring an amount from a credit card to a personal loan helps lower your credit utilization ratio, improving your credit score. Plus, a good credit score can help you get better rates and other terms when you apply for a mortgage.

What Is the Process of Applying for a Personal Loan?

To apply for a personal loan, follow these steps:

1. Check your credit score.
2. Shop around: Compare loan offers from different types of lenders and from other lenders of the same type to find the best one.
3. Determine the lender: Provide the required documents and formally submit the loan application.
4. Complete the application process with your chosen lender, online or in person.
5. Wait for approval and, if approved, review the loan terms before accepting the offer.

How Can I Obtain a Balance Transfer Card?

To obtain a balance transfer card, follow these simplified steps:

1. Research: Look for balance transfer cards with good 0% introductory APR periods, low fees, and rewards programs.
2. Check credit score: Ensure you have a good to excellent credit score to meet the eligibility criteria.
3. Gather information: Collect your Social Security number, employment details, income information, and existing debt details.
4. Apply: Fill out the online application form on the issuer's website or apply in person at a local branch.
5. Await approval: Wait for the issuer's decision, which may take a few days or weeks.
6. Complete the transfer: Once approved, follow the instructions provided by the issuer to transfer your existing balances.