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Personal Loan Vs. Balance Transfer: Which Is Better for Consolidating Debt?

If you’re suffocating under a mountain of debt, you might be wondering if consolidating debt could help your situation. Indeed, debt consolidation can be a great way to cut your interest expenses and reduce the number of bills you’re paying. It can also help you create a roadmap to get out of debt. But is a personal loan or balance transfer credit card better for debt consolidation?

Here are the pros and cons of consolidating debt with a personal loan or balance transfer credit card:

Understanding the pros and cons of each option will help you choose the best strategy to consolidate debt and improve your finances as quickly as possible.

Personal loan

A personal loan is money you borrow to pay for just about anything, such as a dream vacation, education expenses or to consolidate debt.

The pros:

Pro #1: You have fixed repayment terms.

A personal loan comes with a specific interest rate and term so you pay it back in monthly installments over a set period. For instance, you might pay 8% for five years with monthly payments of $700. Your payment stays the same every month, which helps you manage your budget.

Matt Schulz, Senior Industry Analyst at Creditcards.com, says, “A personal loan offers predictability that a balance transfer card can’t match. With a typical personal loan, your payments will be fixed. That’s a big deal for folks who are juggling a bunch of different bills. While these loans’ rates can’t compete with a card’s 0% limited-time offer, they are typically lower than most credit cards’ standard APR.”

Consolidating also simplifies your financial life because you only need to keep track of one bill due date instead of several. You can focus all your effort and attention on making that single payment, counting down the months until your debt is wiped out.

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Pro #2: You pay a lower interest rate.

Consolidating debt with a personal loan makes sense if you get a lower interest rate than you’re currently paying. That allows you to reduce your monthly expenses and get out of debt faster.

Let’s say you have a $15,000 balance on two credit cards. If one charges 16% and one charges 10%, paying them off with a personal loan that charges 9% saves money.

Pro #3: You can use the funds for any purpose.

If you have different types of debt to consolidate — such as credit cards, auto loans or medical bills — using a personal loan gives you the most flexibility. You receive a lump sum in your bank account that you can use to repay any lender, merchant or service provider that you like.

Pro #4: You can build credit quickly.

Having an additional installment loan helps you build credit, if you make payments on time. Plus, using it to pay off credit cards can boost your credit by lowering your utilization rate, which is the percentage of available credit you use on revolving accounts (such as credit cards and other lines of credit).

Although applying for a new loan may ding your credit initially when the lender makes a hard inquiry, having a mix of credit types and a lower utilization rate are more beneficial to your credit over the long term.

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The cons:

Con #1: Your monthly payment may be higher.

Because a personal loan gives you a fixed repayment term, your monthly payment may be higher compared to a minimum payment on a credit card. The payment amount depends on how much you borrow, the interest rate and the length of the loan.

Unlike with a credit card where you can make a minimum payment, with a personal loan you’re required to remit the full payment every month. If you don’t, you can destroy your credit. So, always make sure that you choose an affordable repayment term for a personal loan.

Con #2: You’re charged fees.

Loans come with fees that vary depending on the lender you choose, the amount you borrow and your credit. That’s why comparison shopping with multiple lenders is always a good idea.

Personal loans typically charge an origination fee that ranges from 1% to 5% of the loan amount. Plus, there may also be an application fee or a charge to pay off the loan early.

Con #3: You may keep using credit cards.

If you use a personal loan to pay off credit cards, but continue making charges to them, you may end up deeper in debt. So, use a consolidation as a fresh start and only make credit card charges that you can pay off in full each month.

Balance transfer credit cards

A balance transfer credit card is just like a regular card, except that it includes an incentive — such as 0% interest during a promotional period — when you transfer a balance from another account.

The pros:

Pro #1: You don’t pay any interest.

Skipping interest for a period is by far the biggest benefit of transferring balances. The offer varies by card issuer, but typically lasts from six to 24 months. You can focus on paying down your transferred balance without one penny of interest accruing during the promotion.

Schulz says, “If you’re just looking to avoid the most interest, a 0% balance transfer card can’t be beat for debt consolidation.”

Pro #2: You can build credit quickly.  

Getting a new balance transfer card, or an additional limit on an existing card, instantly raises your available credit, which lowers your credit utilization and boosts your scores. Likewise, the opposite is true when you close a card.

Just like adding an installment loan to your credit history can initially ding your credit, the same is true when you get a new balance transfer credit card, but it can be well worth it. 

The cons:

Con #1: The introductory rate is for a limited time.

The main drawback of consolidating debt with a balance transfer is that the low or 0% rate is temporary. If you don’t pay off the entire debt before the rates expires, your balance may be subject to a much higher rate.

According to Schulz, “You should expect limits as to how much can be transferred to the card. And know that if you can’t pay the transferred balance in full during the introductory period, the remaining balance will be subject to a higher, standard APR. None of these facts make a balance transfer card a bad deal, but they’re important to know.”

Con #2: You’re charged transfer fees.

Balance transfer cards typically charge a fee that ranges from 3% to 5% of each amount transferred, plus many have an annual fee.

For example, if you transfer $2,000 to a card with a 3% fee, you’ll be charged $60, which increases your debt to $2,060. If you can save money despite the fees, you’ll come out ahead.

Con #3: You may have transfer restrictions.

Transfer offers may restrict the types of debt you can move to the card. For instance, some issuers may only allow debt from a different card company. Or they may not allow you to transfer balances from an auto or student loan.

Shifting debt to a lower-rate personal loan or a no-interest balance transfer card is a smart way to save interest. It doesn’t make your debt go away, but can make it much less expensive and manageable.

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