Paying off the debt is never easy. But lower interest rates and smaller payments can alleviate your burden.
When it comes to joint consumer debts such as credit cards and personal loans, two of the most popular ways to lower your rate include balance transfers and debt consolidation loans.
What is the difference between those options and which is the best? They both have pros and cons, but you can make an informed decision once you understand the costs and how your debt is currently configured.
Credit Card Balance Transfers
With a credit card balance transfer, move your debt to a new or existing credit card. To do this, your credit card company can offer promotional convenience checks or you can request the transfer online. Credit card balance transfers are the most attractive when you know that you can pay off the debt quickly.
In a best-case scenario, you can pay no interest on your debt, at least for a limited time. Getting rid of the interest charges helps to stop the bleeding because your loan balance stops growing, and 100 percent of every payment goes toward reducing your debt. But it is crucial to understand the terms of your offer.
Find out if you have to pay a fee to pay balances. The costs are often around 3 percent of the amount you transfer, or a flat amount in dollars – whichever is greater. Any savings that you get from a lower interest rate will have to relate more than to the transfer fee. You would also be on new annual fees if you open a new credit card.
The best interest rates are available for customers with good credit. You might see tempting offers in advertisements, but make sure to view what the card issuer actually offers you after viewing your credit. Even if you were 0 percent in April, that rate wouldn’t last long. Check to see when the speed changes and what happens after the promotion period ends. In some cases you have to pay your balance during the promotional period to avoid deferred interest charges.
Balance transfer offers are not necessarily bad for your credit, but they can cause problems. Every time you apply for a new card, lenders look at your credit history, and those questions can thing your credit scores. Having too many consumer accounts (such as credit cards) opened can lower your score. If you end up using credit card balances, you need to use them as a debt payout tool not a debt increasing tool. Avoid using the card you paid to get deeper into debt.
Instead of using credit cards, you can consolidate debt with a personal loan, a type of secured loan, or a P2P loan. A large loan would allow multiple loans, be combined and get everything in one place. Debt consolidation loans often come with a fixed interest rate, so they make more sense if credit card promotional periods are too short. For example, a 0 percent April offer for three months may not be useful if you expect to pay your debt for three years.
You may or may not have to pay upfront fees for a debt consolidation loans. With some loans, you will see obvious costs, such as processing or initiating fees. With other loans the costs will be invisible, but they are built into the interest. Compare different loans to the combination of upfront costs and interest charges that you will find the most benefits.
The price you pay depends on the type of loan you use. A personal unsecured loan will have a higher rate than a secured home equity loan, for example. However, you will probably have a rate that is lower than standard credit card interest rates – but “teaser” or promotional credit card rates should be even lower, at least for a few months to pay interest.
If you plan to pay off the debt for several years – which is longer than any credit card promotion – you might do better with a debt consolidation loan. The interest rates can be variable, which means they will move up and down like credit card rates, or they can be set. Fixed rates make it easier to plan because you know what your monthly payments are for the entire duration of the loan. But fixed rates usually start out higher than the variable interest.
As with credit cards, new loans lead to questions that can affect your credit scores, at least in the short term. In the long run, a number of debt consolidation loans can potentially be better for your credit than balance transfers.
Credit scores are higher if you use a mix of different types of credit, and the installment loans make you more attractive than a borrower based solely on credit cards. If you are a heavy credit card user, it seems that you are spending your means for consumer goods and paying high interest, which is not sustainable.
A debt consolidation loan might suggest that you have made a commitment to pay off debts, and you use the right type of debt for that purpose. That means you are a smart borrower, so you have the chance to repay other loans in the future. As long as you make payments on time and only on debts that you can afford, your credit will strengthen.
For some debt consolidation loans, you may have to pledge collateral. That means you give the bank permission to take your assets and sell them if you fail to repay the loan. For example, you might consider your home property as part of a home equity loan, or you could use your car as collateral.
Keep unsecured loans unsecured: Collateral can help you get approved, but pledging your assets is risky. What if things don’t work the way you planned — can you live without your house? Can you get to work and earn an income without leaving your car? It is best to keep unsecured unsecured loans because the only risk is your credit. If you have a home equity loan to pay off unsecured credit card debt, you will increase your risk dramatically. If something unexpected happens, you can lose your home in foreclosure.
Refinancing secured loans: If you already have debt that is covered by collateral, consider refinancing these loans separately. For example, use a balance transfer or debt consolidation loan for unsecured debts, and get another loan for your secured debts. That said, if you can pay off guaranteed debts and turn them into unsecured debts, you will reduce your risk – but make sure it is not worth any additional costs.
Student Loans: Be careful
If you have student loans, do some homework before consolidating these loans or paying them off with a personal loan. Government loans offer unique benefits, such as the possibility of loan forgiveness or the possibility to postpone payments. If you refinance or consolidate with a private lender, you can lose access to those borrower-friendly features.