Credit Card vs Personal Loan: Which is Better For Debt Consolidation

Give yourself some breathing room while you tackle your debt
5 minute read | 3/13/19March 13, 2019

Here are some alarming figures —

More than 35% of all American adults with a credit file have some record of debt collections on their credit report, according to a study by the Urban Institute. The study also reported that those same people had an average balance of more just over $5,100 in collections.

A FINRA report further indicates that 32% of Americans only make the minimum payments due on their credit cards.

If you find yourself among this group of people and you'd like to pay your debt off faster so you can have a little more breathing room, you're likely considering some form of debt consolidation.

In this article, we're going to look at the differences between using a credit card versus a personal loan to consolidate debt, and determine which one is the best option for you.

Personal Loans

Personal loans are an unsecured lending option that allows buyers to access funds to use for whatever they need. The loan is considered unsecured because it isn't tied to a home or other form of collateral.

Personal loans come in a lot of different flavors with interest rates and terms running the gamut from low-cost to obscenely expensive. They are available from a variety of lenders including credit unions, banks, and online lenders.

The Impact on Your Credit

Personal loans, like any other loan or credit card, can impact your credit score in a variety of ways. Any time you apply for a loan or line of credit, your score could be affected when lenders pull your credit report and/or score. Further, opening a new line of credit could affect your credit utilization.

If done correctly, a personal loan could actually raise your credit score as it extends the difference between the amount of credit you have available and what you actually use. This is one reason people consider personal loans for consolidating debt.

Is it a good idea to get a personal loan to pay off debt?

Maybe. If you have the discipline to put your credit cards away after you use a personal loan to pay them off, this method could be very beneficial. If, however, you take your recently cleared cards and start spending again, you could find yourself in serious financial trouble.

Benefits of Using a Personal Loan

  • Personal loans often higher amounts of money, so if you have a substantial amount of credit card or loan debt, this could help consolidate it all into one bill.
  • There are a lot of lenders who offer personal loans for individuals with spotty credit.
  • Personal loans offer fixed repayment terms. This means that you and the lender agree on a certain payment amount every month, and it doesn't change. Most personal loans are fixed-rate, so you can rely on the same payment every month until the balance is gone.
  • Personal loans offer lower interest rates than most credit cards. If you have credit cards with higher interest rates, you may be able to save money by consolidating all of your debt into a personal loan.
  • A personal loan extends the amount of available credit you have, which can help raise your credit score.

Drawbacks of Using a Personal Loan

  • If you have bad credit, your interest rate may be higher. Because the loan is unsecured, the lender may offer loans with higher rates to protect their investment.
  • Fees. Personal loans have fees that can add to your total amount owed. Fees to look out for include a loan origination fee and early repayment fees. Some lenders also charge insurance and processing fees.
  • If you use a personal loan to clear credit cards, you may be tempted to start spending on your credit cards again.

Balance Transfer Credit Cards

A balance transfer credit card means you take the balance you owe on one credit card and put it on another card. These cards typically offer promotional rates like 0% interest for 12 to 18 months.

Depending on the card, you may be able to transfer other debt, like a loan, to the balance transfer card. Most major credit card companies offer balance transfer cards.

The Impact on Your Credit

Like personal loans, a balance transfer can affect your credit score via inquiries and credit utilization. The biggest concern is applying for too many balance transfer cards at the same time. With loans, credit reporting companies may view multiple inquiries in a month as "shopping for interest rates," so your credit score may not get dinged as much. However, applying for several credit cards in a short period of time reflects negatively on your credit score.

Is a balance transfer a good idea for consolidating debt?

It can be. The biggest benefit of a balance transfer card is that they often offer promotional rates of 0% interest. This means that when you pay money towards the debt, all of it goes towards the principal. This could make it much easier for you to pay your debt off quickly.

You'll want to pay close attention to the terms of your balance transfer card because shorter terms may not be very helpful, and some cards charge a certain percentage of your balance as a fee.

Benefits of Using a Balance Transfer Card

  • Promotional rates can be amazing. If you can snag a 0% percent interest rate for 12 to 18 months, you can make a serious dent in the amount you owe, very quickly.
  • Transferring your debt to a balance transfer car increases the amount of credit you have available, which can help boost your credit score.
  • Minimum payments may be relatively low, making a transfer card an affordable option.
  • Balance transfer cards may be a more affordable option if you don't have a lot of debt types.

Drawbacks of Using a Balance Transfer Card

  • Transfer cards charge a transfer fee of up to 5% of the balance you owe, so your total debt owed actually increases, at least temporarily.
  • Promotional rates are temporary, so your payment could change. If you don't pay off your total debt before it's paid off, your minimum payment could adjust higher, depending on the balance you have left.
  • You need a relatively healthy credit score to qualify for the best promotional offers. If you score is spotty, you may not even qualify for no interest terms.
  • Most companies won't let you transfer student loan or auto loan debt to this type of card.

Personal Loan or Balance Transfer Card — Which is Better?

Both a personal loan and a balance transfer card offer can benefit consumers who want to consolidate their debt.

Both are practical options that can be very effective. To decide which option is better, you'll want to take a look at your finances and see which option makes the most sense for you.

Let’s compare some of the pros and cons of each, so you can determine which works best for you.

How Funds Are Used

Personal loans: You can use the money any way you want, including applying it toward student loans or other debt.

Balance Transfer Card: Typically involves transferring debt from one credit card to another, though some may allow other types of debt.

Interest Rates

Personal loans: Varies. Typically rates sit between 5% and 36%. You’ll have a higher interest rate with a lower credit score.

Balance Transfer Card: Regular offer 0% interest as a promotional offer. Then rates can jump up to regular rates, typically between 12% to 29%.

Repayment Terms

Personal Loans: Personal loans are a fixed rate. You'll have the same interest rate and payment the entire term of your loan.

Balance Transfer Card: You'll have a minimum payment due every month. If you don't pay off the balance before the promotional period ends, your payment could change.

Fees

Personal Loans: Personal loans include charges like origination fees and processing fees. Some lenders offer insurance and/or charge prepayment penalties.

Balance Transfer Card: Balance transfer cards typically assess a fee of 3% to 5% of the total transfer amount. (On a transfer of $5000, that's $150 to $250).

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