As you tackle looming credit card debt, you may consider two popular options often advertised by lenders: balance transfers and debt consolidation loans. Both serve very unique yet similar purposes, however depending on your situation, neither may be best for you.
Before we dive into each product and our suggestion, first let’s set the table as to why you are reading this. Credit Card debt in America is on the rise at a record-setting pace, and when you think that just one year ago Americans owed $870 billion dollars to credit card issuers, which was up 5 percent from the same time in 2017. While roughly half (48%) of credit card users are able to make the minimum payments on time every month, that number is starting to slowly go in the wrong direction as the burden of debt begins to weigh heavy.
Let’s explore the two popular strategies for reducing your credit card debt. Note, we did not say eliminating. You can only eliminate your credit card debt for good if you commit to not getting back into debt, and pay the actual debt off. Moving the debt from one source to another, while financially smart, does not solve the true issue.
A balance transfer could be an excellent way to save money via interest on existing credit card debt, by moving one or more of the balances currently owed to a new card that charges you 0% interest for a defined period of time. Many popular credit card issuers will run promotions ranging from 3 months to 12 months on any balances you bring over to them. If you are financially able to pay off those balances, you could save hundreds of dollars in interest that otherwise was piling on.
Many credit cards that offer balance transfer promotions require a good FICO score (generally 660 or higher) to qualify. If you are approved, the card issuer will provide the credit limit available for balance transfers. In some cases, you can use up to 100% of the total credit limit of the card, while in others you are restricted to 50%.
Some credit card companies allow you to enter in balance transfer information (such as your current credit card account number, mailing address for payments, etc) if you are automatically approved on their website when submitting your application, so make sure you have the statements of the cards you are considering transferring available. You do want to take into consideration most balance transfers do incur a fee, which is 3% of the balance you are moving. For example, if you transferred $2,000 from your Capital One Credit Card to a new Discover IT Card, Discover would charge you $60 (3%) of the balance, so your first statement (assuming you have no additional purchases) would be $2060, and you would have 12 billing cycles to pay that balance off.
Once you move the balance from your old credit card, many people ask, what do they do with that account. This is where advice online will vary considerably. Some will note that you should “sock drawer” the old credit card, keeping the account open, however refraining from using it for future purchases. Others advise to cut up the physical card and close the account, as it got you in trouble to start with. The answer truly is “it depends”. If your goal is to become completely debt free, and you are honest with yourself, and realize you do not have the financial discipline to use credit cards responsibility without getting in more trouble, cutting up and closing the card is a good idea. The credit payment history will remain on your credit report, and while your score will take a hit in the short term, your primary goal is not building your FICO score, it is to become free of debt.
An alternative to moving debt via balance transfers would be consolidating debt into one low monthly payment. The primary goal of a debt consolidation loan is to combine high interest rate credit card/consumer debt into one fixed monthly payment, in which you will have equal installments to pay until the balance is zero. In many cases, the debt consolidation will save you money immediately via lowering your monthly payments. Debt consolidation loans can be both unsecured (personal loans) as well as secured with collateral (home equity loans). They are not revolving accounts, so the monies you are approved for will be dispersed when the loan is signed to pay off creditors. While many people transfer balances on credit cards primarily to lower credit card utilization, which in turn increases their FICO score and provides another revolving tradeline, a debt consolidation loan is solely in play to simplify paying off your existing debt.
Many people who are considering taking out a debt consolidation loan are comfortable with closing the accounts of the bills they are transferring the debt from, and no longer want to juggle making multiple payments to various creditors. You may be able to get approved for a debt consolidation loan with a lower FICO score than a balance transfer credit card from your local financial institution, however underwriting terms for your loan could vary. There are traditionally little to no fees associated with the debt consolidation process, however review any product being offered by your bank or credit union to ensure you understand the terms.
If you have debt with higher interest rates that you have the ability to pay off faster via a balance transfer or debt consolidation loan, it is certainly worth considering both options. Balance Transfer credit cards are ideally great options if you are looking to lower your utilization of existing credit, while also move debt from higher interest rate cards to a special promotional rate for a set period of time. During that period (12 months), if you are focused on attacking that debt, you can not only save money on interest from the prior debt, but also see a lift in your FICO score. Debt consolidation loans are primarily focused at debt reorganization and simplification, and provide the borrower the ability to make one payment on existing debt on fixed, installment terms (similar to their mortgage or auto loan). These loans are generally easier to be approved for than balance transfer cards, however underwriting may require you to close the accounts of the existing debt, depending on your creditworthiness.