Credit Card Refinancing vs. Debt Consolidation - Which Is Right For You?
High-interest credit card debt can rack up quickly and wreak havoc on your personal finances. In this situation, you have two key options for repayment: credit card refinancing and debt consolidation. Each option has pros and cons, which depend largely on how much you owe, how quickly you can repay it, and what your credit score is.
What Is Credit Card Refinancing?
Credit card refinancing refers to moving one or more high-interest credit card balances onto another credit card with a low or 0% interest rate. With this method, you can lower your interest rate temporarily, which allows you to pay more each month, while paying less in interest.
The 0% interest rate is temporary, as credit card companies offer the low rate as an introductory offer, typically for 12 to 18 months. Once that period is up, the interest rate goes up, usually anywhere between 15% and 20%.
This method is sometimes referred to as a balance transfer, as you’re transferring your high-interest credit card debts to another card. This option typically comes with a transfer fee, which is a charge for moving your debt onto the new card, and can be up to 5% of the balance. The goal here is to pay off the debt before the end of the introductory period so that you avoid the high interest rates.
Credit Card Refinancing: Pros and Cons
- Easy to start: To begin, you just need to find a card that offers a low or 0% interest rate, which makes this method quick and easy to set up. Still, you should shop around to find the lowest interest rate available to you for the longest time period. You might also consider what the interest rate will jump to after the initial period.
- Low interest: By consolidating all of your credit card debt onto one card with 0% interest, you can avoid paying the high interest rates of the original credit card(s).
- Shorter timeline: Since the goal of refinancing is to pay off the debt within the 12- to 18-month introductory rate period, you can pay off your debt quickly. Additionally, paying zero interest allows you to pay more toward the debt itself.
- Credit score requirement: To qualify for a 0% introductory rate, you’ll need a good to excellent credit score. If you have a poor score, you’ll have a hard time finding a credit card company that will make you an offer.
- Short timeline: Since the low interest rate only lasts for a limited amount of time, you’ll need to be able to make big payments within a short period of time.
- Credit limit: You’ll need to qualify for a credit limit high enough to take on the credit card debt that you want to consolidate and refinance. For example, if you only qualify for $10,000 but you have $15,000 in debt, you’ll still have $5,000 on your old, high-interest card.
- Transfer fees: To transfer your debt onto your new card, you’ll likely be charged a transfer fee that is anywhere between 3% to 5% of your balance. Occasionally, credit card companies offer interest-free transfers for a limited time.
What Is a Debt Consolidation Loan?
A debt consolidation loan allows you to pay off high-interest credit card debt. If you use this method, you’ll get an upfront payment from a lender which you can use to pay off your credit cards. Then, you’ll make monthly payments at a fixed interest rate to your lender. The loan term is typically 3 to 5 years.
The fixed interest rate will be lower than your credit card interest rate. For example, a home equity loan is usually 5% to 8%, while credit card interest rates can be as high as 25%.
Debt consolidation loans can either be secured or unsecured. A secured loan is a loan that is backed by some sort of collateral, like a home equity loan. An unsecured loan is not backed by any collateral, like a personal loan.
Since you agree to a set time limit when you sign up for the loan, you also agree on set monthly payments. This makes it easy to plan for the monthly payment within your budget. Before selecting a debt consolidation loan, you should compare fees, APRs, term lengths, and required credit scores.
Debt Consolidation Loan: Pros and Cons
- Longer timeline: Debt consolidation loans allow you to take your time with repayment. Since you’re signing on for a 3- or 5-year loan, you don’t have to rush to get it paid. However, most lenders allow you to make higher monthly payments than the minimum, if you desire.
- Low, fixed rates: These loans provide you with a fixed interest rate, as well as a set monthly payment, so you know exactly what to expect each month. This allows you to plan and budget, while also saving a lot of money by not paying high credit card interest rates.
- Less pressure: If you have a lot of credit card debt, a debt consolidation loan allows you to pay it off at a reasonable pace. Unlike credit card refinancing, you can pay off the loan over a long period of time with less pressure.
- Higher risk: If you choose a home equity loan, you run the risk of losing your home. This would only occur if you don’t pay off the loan in the agreed-upon time.
- Origination fees: Personal loans often require an origination fee for the lender to process your loan. These fees can be as high as 8% of the loan amount and typically depend on your credit score.
- More interest: Since you’re paying the loan out for up to 5 years, you’ll pay more interest than you would with credit card refinancing. However, most lenders allow you to pay off the loan quicker if you prefer, so you may be able to save on some of that interest paid.
Which Is Right for You: Credit Card Refinancing or a Debt Consolidation Loan?
To choose between credit card refinancing and a debt consolidation loan, you’ll need to consider how much you owe, how fast you can pay off the debt, your credit score, and the fees associated with each option.
You can usually pay off a lower amount of debt more quickly, in which case credit card refinancing would be ideal. A higher amount of debt lends itself to a more long-term plan, like that of a debt consolidation loan.
Next, consider how quickly you are able to pay the debt off. If you can pay it off within a year and a half, refinancing is likely the better option.
Your credit score, assets, and income will also come into play when determining what you qualify for. You’ll need a credit score higher than 680 to qualify for a 0% introductory offer when refinancing. If you want to go with a loan, your lender will review your income and credit score when determining your interest rates. If you have assets, like a home, you may also get a different type of loan and potentially better interest rates.
Additionally, your personal timeline should come into play. If you need to get rid of debt right away, you may be better off with refinancing, as there are fewer barriers to getting started.
The Bottom Line
Ultimately, your method of debt repayment depends on many personal factors. If you have a good credit score, want to pay off debt quickly, and have the means to do so, credit card refinancing is likely best for you. In that case, just be sure to ask about transfer fees.
If you need a solution that fits into your budget and you don’t mind spending a few years footing the bill, a debt consolidation loan would be a better fit. As long as you’re in no hurry, you can have a set bill and an interest rate that fit your needs – just be sure to ask about origination fees.