Debt Consolidation Loan vs. Balance Transfer

Americans held a record-breaking $1.08 trillion dollars in credit card debt in 2023, according to the New York Federal Reserve. Debt consolidation can help you pay down your portion of that hefty balance, and isn’t necessarily limited to just credit card debt, either. Two common options for consolidating your high-interest debt are debt consolidation loans and credit card balance transfers.

Here’s what to know about each method so you can decide which option is right for you.

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What is a debt consolidation loan?

A debt consolidation loan is a type of personal loan used to consolidate your existing high-interest debt. You can use the proceeds from the loan to pay off your credit card bills, for example, leaving you with just one monthly payment to the lender.

Debt consolidation loans can offer lower APRs than credit cards, as well as longer repayment terms, allowing you time to pay off the debt and get back on your feet. The average interest rate for a 24-month personal loan was 12.17% in August 2023, according to the Federal Reserve. Personal loans also usually have a fixed APR, which means your rate won't change over the life of the loan. You can find debt consolidation loans from banks, credit unions, and online lenders.

There are a few different types of debt consolidation loans:

• Secured loan: Secured loans use an asset, such as your house or car, as collateral. If you default, the lender can seize your collateral.
• Unsecured loan: With an unsecured loan, all you need is your signature: no collateral required.

Check Out: How Debt Consolidation Helps Your Credit

If you own a home and have built up enough equity, you may also be able to borrow funds to pay down debt using a home equity loan, line of credit, or a cash-out refinance.

The interest rate on debt consolidation loans can vary, but you’ll likely see annual percentage rates (APRs) between 6% and 36%. The APR is the total cost of borrowing, and includes the interest rate and any upfront fees the lender charges, making it a good way to compare between different loan options. You’ll have better odds of being approved and receiving a lower interest rate with a good FICO score (between 670 and 780) or higher.

Repayment terms on debt consolidation loans are typically between one and seven years, although some loans may give you even longer to pay back what you’ve borrowed. Debt consolidation loan lenders may charge upfront origination or application fees, and they may also charge late payment fees. Check any loan agreement before signing to be sure you understand the full terms and conditions.

You can often prequalify for a debt consolidation loan, which won’t affect your credit score. Formally applying, however, will drop your score by a few points temporarily. Remember that while it can give you an idea of the rates and terms you could qualify for, prequalification is not an offer of credit, and your final rate may be different.

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What is a balance transfer?

A balance transfer lets you move your credit card balance from one card to another. Balance transfer cards may offer a low or even 0% introductory APR, which you can use to pay down your balance without accruing interest.

After the introductory period, which often ranges from six to 21 months, the APR adjusts to the regular APR. Credit cards typically have variable rates, which means the regular APR is subject to change based on market conditions.

Balance transfers typically incur a balance transfer fee, often 3% to 5% of the amount you’re moving over. Keep in mind that if your credit score is fair or poor (below 670), you may find it difficult to be approved for a new balance transfer card. Check existing credit cards to see if you have any 0% APR balance transfer offers.

Pros and cons of debt consolidation loans and balance transfers

Debt consolidation loans may have larger available loan amounts and longer repayment terms than balance transfers. They can also be used on a wide variety of debt, as well as for credit card consolidation. You may also be able to find bad-credit loans if your credit score is low.

Compare the pros and cons of each in the table below.

Renee Newman, chief experience officer at First United Bank, recommends figuring out which method will work best for you, as well as creating a savings account for emergency funds.

“A debt consolidation loan is just like any other debt — it will only work if you are disciplined in making your payments on time and don’t take out any new credit,” she said. “You didn’t accumulate the debt overnight, so you can’t expect one thing to solve the issue forever.”

Newman encourages people to adjust their mindsets, but also to not forget the joy in life.

“Building a financially responsible practice will help you stick to the payment schedule and pay off your loans,” she said. “It is also important to figure out ways to reward yourself and celebrate the milestones as you pay down the loans, so it doesn’t feel punitive.”

See Also: Debt Consolidation vs. Personal Loan

How to choose

Whether you should consolidate your debt with a personal loan or a credit card balance transfer will depend on how much debt you have and your current APR.

Debt consolidation loans are best for larger loan amounts and longer repayment periods.

Balance transfer cards, on the other hand, are better suited for smaller loan amounts and shorter repayment periods; most offer introductory APRs for just six months to a year.

“You have to commit and make big strides during that teaser period for the balance transfer method to be successful”, said Christopher Naghibi, executive vice president and chief operating officer at First Foundation Bank.

Plus, you’ll be limited to the amount of your credit line, which could hold you back if you have more debt than your card issuer will allow you to transfer.

Here are some things to consider to help you figure out which method will work best for you:

1. How much debt do you have? Add up your current high-interest debt, including credit card balances and other debt you’d like to pay off, so you know how much you’ll need to borrow.
2. What kind of debt is it? Consider what kind of debt you’re seeking to consolidate. Credit card balances are easier to transfer to another card than other kinds of debt are. If you’re consolidating non-credit card debt, such as a traditional installment loan, you might opt for a debt consolidation loan instead.
3. What is your current interest rate? Market fluctuations mean interest rates are always changing. Know what you’re paying now so you can compare APRs, which include the interest rate and upfront fees.
4. What is your credit score? If you haven’t done so recently, get a free copy of your credit reports and find out your credit score, as well. Lenders and card issuers will look at your score to determine whether you qualify for a particular product, and a good or excellent credit score can help you land better rates and larger loan or credit limit amounts. Visit AnnualCreditReport.com for free weekly credit reports.
5. What is your budget? You’ll also need to have an idea of how much money you can afford to throw at your debt each month. If you don’t have a lot of wiggle room, a debt consolidation loan (with its longer time frame for repayment) may be the better option if it allows for smaller monthly payments.
6. How much time do you need? Repayment terms can affect your monthly payments. Longer repayment periods often result in lower monthly payments, as you’re stretching the principal over a long time frame. On the other hand, shorter repayment terms, if you can swing one, may help you get out of debt sooner and pay less in overall interest.

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