Debt Consolidation Loan vs Balance Transfer Credit Card: Which Is Right for You?

debt consolidation loan

The cost of debt, like everything else in America, has been steadily rising since we emerged from the 2020 pandemic. Those historically low interest rates are long gone. While inflation is less severe, it sent prices high enough that the average person is still feeling the pinch. This combination of factors has many consumers looking into a debt consolidation loan or a balance transfer credit card.   

Is one option better than the other? Read on to take a closer look at how debt consolidation loans and balance transfer cards compare.

What Is a Debt Consolidation Loan?

A debt consolidation loan is a loan taken out specifically to pay off outstanding balances on credit cards. The goal behind it is that you get a lower interest rate on the loan than you are paying on your credit cards, making it more affordable to pay off your debt.

The most popular type of loan used for this is an unsecured personal loan. The term “unsecured” means that the borrower doesn’t need to post security or collateral to get approved by the lender. Credit card debt is also unsecured debt.

There are two benefits to using a debt consolidation loan to pay off credit cards. The first is that you can consolidate several monthly credit card payments into one monthly loan payment. That makes it easier to budget and makes it less likely that the debt holder will miss a payment. Ideally, you’ll want to put the loan payment on autopay if you choose this option.

The other advantage of credit card consolidation with a personal loan is the potential interest rate savings, as mentioned above. The average APR for a new credit card currently sits at 24.59%. The average interest rate for a personal loan is 11.54%. These rates are both dependent upon the debt holder’s credit score, but the disparity between the two remains striking nevertheless. And has a huge impact on what you’ll pay over time for borrowing that money.

What Is a Balance Transfer Credit Card?

A balance transfer credit card is a credit card that allows its holder to transfer outstanding balances from another credit card. (You may also hear this called “credit card consolidation.”) This is not a service that’s available from all credit card companies. The practice is generally used to entice consumers into changing credit card providers. This usually happens with an appealing low-APR introductory offer (often 0% for an introductory period of up to 24 months). During the time of low or no interest, the card holder can play catch-up and pay down their balance… or at least that’s the concept in theory.

It sounds like a great deal, but it’s wise to proceed with caution. The key phrase to pay attention to with a balance transfer is “introductory offer.” That low interest rate will expire after a certain number of months. At that point, your debt will start to be assessed that hefty interest rate again. This option will benefit you only if you can pay the entire debt before the interest rate ticks up.

Low-interest balance transfer cards are easier to find when general interest rates are low. Special introductory offers are less common when rates are high, but there are some of them out there. Read the fine print carefully before agreeing to a balance transfer card. You might be surprised to find that the introductory rate doesn’t apply to new purchases, for example. If you can’t pay off the entire debt before the introductory period expires, it might not be a good idea to choose this option.

Comparing the Cost Savings of These Options

Each person’s financial situation is unique. There’s no single answer to whether debt consolidation or balance transfer is better, but here are some guidelines that could help.

  • Debt consolidation can save you money if you do it right. When comparing debt consolidation options, the first factor you’ll want to measure is how much money you can save. A personal loan could be 10% to 15% cheaper on the interest rate side. However, stretching that loan out for several years could mean you pay out more overall. Have you done that math? Use an online calculator to uncover the true costs.
  • It’s important to look at every scenario and be realistic about what you can commit to. For example, a shorter term on the personal loan means you’ll have a higher monthly payment to make. That lowers the total debt you’ll pay, but you might get yourself into trouble further down the line if you default on the loan. That defeats the purpose of consolidating debt.
  • The balance transfer option could save you even more money, but only if you can pay the debt off during the introductory period. A 0%APR could be a savings of 25% or more, but that credit card provider might have a regular APR of close to 30%. When the introductory period ends, you could end up paying 5% more on your debt than when you started.

In all of these scenarios, it’s wise to set aside time to really dig into the numbers using online tools. Or you might want to talk to a credit counselor about your options.

How These Options Impact Your Credit Score

Either of these credit card consolidation options could hurt your credit score, but that may be part of the process as you work to pay off your debt.

  • The debt consolidation loan counts as “new credit,” which will make your score go down a few points. That effect is temporary, but you should be prepared for it. Missing loan payments or making them late will also lower your credit score, so budget carefully.
  • A balance transfer to consolidate debt involves opening a “new” credit card account. It also takes time for a balance transfer to show up on your credit report, so the “amounts owed” variable used to calculate your credit score may go up for a few months. That is also temporary, provided you don’t use the balance transfer credit card for new purchases.

The Bottom Line: Which Option Is Right for You?

Paying off your personal loan with on-time monthly payments will eventually improve your credit score. Paying the balance transfer credit card on time will accomplish the same thing, so this essentially comes down to spending behaviors. You may be looking into debt consolidation because of poor decisions in that area. This is an opportunity to start over.

Your decision may also be determined by what’s available to you. Balance transfer cards are hard to get if you don’t have a high credit score. Personal loan rates vary based on the creditworthiness of the applicant. Shop around online to see what’s available and do the math on every offer. Your goal should be to save money. The convenience of a single monthly payment is secondary. Keep that in mind as you shop for the best fit for your situation.  

Kevin D. Flynn

Kevin D. Flynn

Kevin D. Flynn is a former financial professional, business coach, and freelance financial writer. He lives in Leominster, Massachusetts with his wife Evelyn, two cats, and ten wonderful grandchildren. When he’s not working, you’ll find him at the golf course or on his back porch reading classic sci-fi novels.

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