Balance Transfer vs. Personal Loan: Which Should You Choose?

Most Americans carry some credit card debt and in some cases, their monthly debt payments may be uncomfortably high. For those people, debt consolidation may be the best way to save money and create a workable debt repayment plan, but what’s the best way to consolidate debt?

At Addition Financial, we often talk to our members about the benefits of a credit card balance transfer vs. personal loan for debt consolidation. Each method has its advantages and disadvantages, so it’s important to make your decision from a place of knowledge. Here’s what you need to know to choose the right debt consolidation method for your situation.

What is a balance transfer and how does it work?

A balance transfer occurs when you apply for a credit card with a low interest rate and transfer your existing credit card debt to the new card. In many cases, credit card issuers will offer a low introductory rate, sometimes even a 0% rate, on balance transfers. Transferring debt in this way results in a monthly payment that’s lower than what your combined payments were prior to consolidation.

How does a balance transfer work?

There are four basic steps involved in a balance transfer, as follows:

  1. Identify and apply for a low interest rate credit card. You’ll need to compare introductory rates and all conditions, including what will happen to your interest rate after the introductory period ends. Most credit card issuers will want a minimum FICO score of 690 to qualify for a balance transfer.
  2. Initiate a balance transfer. You will need to identify any balances you want to transfer to the new card. You’ll need to provide the issuer’s name, the balance, and the card information to make the transfer.
  3. Wait for the transfer to occur. It may take up to two weeks for a credit balance transfer to be completed. When it does, you will see the old balance appear on your new card, plus any balance transfer fee.
  4. Make payments on your new card. After your balance transfers are complete, you’ll be responsible for payments on the transferred balances on your new credit card.

We’ll get into the pros and cons of balance transfer later, but you should be aware that there are fees involved and that introductory APRs may change and increase your payments if you don’t pay your balance in full before the introductory period ends.

How does using a personal loan for debt consolidation work?

If you don’t think a balance transfer is right for you, then another option to consider is taking out a personal loan to consolidate your debt. A personal loan may be obtained from your credit union or from a bank. Once the loan is approved, money will be transferred to your debtors after the closing to pay off your existing debt and after that, you’ll make monthly loan payments.

How does a personal debt consolidation loan work?

The process of applying for a personal loan to consolidate debt is a straightforward one. Here are the steps involved:

  1. Compare rates and choose a lender. Most lenders will allow you to complete a pre-qualification with a soft credit check that won’t impact your credit score. You can use this step to identify the lenders with the most advantageous terms.
  2. Complete a loan application. After you choose a lender, you’ll need to complete a loan application. Your lender will require proof of employment and income, proof of residence, a photo ID, and may require additional documentation if you’re self-employed
  3. Close on the loan and provide information about balances to be paid. Once your loan is approved, your lender will schedule the closing. You will need to provide payoff amounts and wire instructions, so your lender can pay off your existing balances.
  4. Make monthly loan payments. With your individual debts paid by your lender, the final step is to make on-time monthly payments to your lender to pay your loan.

In the next section, we’ll explore the pros and cons of debt consolidation loans and balance transfers to make sure you understand how each option works.

Balance transfer credit card vs. personal loan pros and cons

Balance transfer credit cards and personal debt consolidation loans both have their advantages and disadvantages. Before you proceed with either option, it’s important to understand the benefits and risks of each.

Pros and cons of balance transfer credit cards

Let’s start with the pros and cons of balance transfer credit cards as we see them.

Pros of balance transfer credit cards

Here are some of the most significant benefits of consolidating your debt with a balance transfer credit card:

  • You can consolidate payments, so you have only one credit card debt payment each month instead of keeping track of many payments.
  • You may end up paying less if you can qualify for a card with a low interest rate–and in some cases, you may pay no interest if you have a 0% introductory rate and can pay your balance before the introductory term ends.
  • You may be able to find a card with better terms than your existing card even after the introductory rate expires; one example would be transferring a balance from a card with an annual fee to one with no annual fee.

Cons of balance transfer credit cards

Now, let’s review some of the potential risks of consolidating your debt with a balance transfer card:

  • Most balance transfer cards offer an attractive introductory rate but it may expire in as little as a few months. Be sure that you understand what will happen to your interest rate after the initial balance transfer offer.
  • You will pay a balance transfer fee of between 3% and 5% for most cards, which will add to your debt. For example, if you had a balance of $10,000 and a transfer fee of 3%, you would pay $300 to transfer your debt.
  • If you’re not careful, a balance transfer card may lead to increased spending. You’ll need to address any underlying issues that caused you to accumulate debt to be sure that you don’t end up repeating those mistakes.

Pros and cons of debt consolidation loans

Now, let’s explore the advantages and disadvantages of debt consolidation loans.

Pros of debt consolidation loans

Here are some of the most important pros of consolidating debt with a personal loan:

  • You’ll go from having multiple monthly debt payments to having just one—assuming you get a loan large enough to consolidate all your debt.
  • You are likely to have a lower interest rate than you would with credit card debt. (Interest rates for personal loans are significantly lower, on average, than credit card interest rates.)
  • You’ll have a fixed repayment schedule and will know exactly when your debt will be paid off.
  • You may see an improvement in your credit score as you make on-time payments.

Cons of debt consolidation loans

There are a few potential downsides of debt consolidation loans that you should understand before you select this option:

  • As is the case with any loan, you will need to pay an application fee and closing costs, which will be between 2% and 5% of the loan amount.
  • It’s not a guarantee that you’ll end up with a lower personal loan interest rate, particularly if you don’t have an excellent credit score.
  • Debt consolidation with a loan carries the same risk as a balance transfer when it comes to spending habits. It’s important to have a plan to reduce spending, so you don’t wind up with even more debt to repay.

credit card debt consolidation infographic

How to decide between a balance transfer and personal loan for debt consolidation

Here are some tips to help you choose between a balance transfer credit card and a personal loan if you want to consolidate your debt.

Read the fine print

The first step is to make sure that you understand every term and condition attached to a balance transfer credit card or a loan agreement. Specific things to consider include the following:

  • Interest rates compared to your current rates
  • Potential changes in interest rates; for example: how long is the introductory rate in place on a balance transfer card? Will your loan rate be fixed or variable?
  • How much will the closing charges or balance transfer fees be?
  • Is there an annual fee on the balance transfer credit card?

Read everything and ask questions to clarify anything else you don’t understand.

Crunch the numbers

One of the most important things you can do is to calculate the total amount you will pay with each option. Make sure to include the following:

  • Your monthly payment amount—for a credit card, we suggest paying as much as you can afford each month rather than the monthly minimum to expedite payment of your debt. 
  • Add closing costs or your credit card balance transfer fee to your total expense.
  • Calculate interest, particularly if you don’t think you’ll be able to pay your entire balance on a balance transfer card before the introductory fee expires.

As a rule, your best option will be the least expensive option when you factor in up-front costs and interest.

Create a budget

Whichever option you choose, we suggest creating a budget to address any issues with overspending. If you skip this step, either option may lead to increased debt and bigger financial issues down the road.

Consolidate your debt with help from Addition Financial

Debt consolidation can be helpful for anybody who’s carrying balances on credit cards from month to month and wants to save money on interest. Depending on your individual circumstances, either a balance transfer or a personal loan may be the right answer.

Are you looking for a balance transfer credit card with attractive rates and no balance transfer fee? Addition Financial can help! Click here to apply for our Platinum Low Rate credit card today.

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