Debt Consolidation vs. Refinancing

Consolidating and refinancing are the two major choices when dealing with credit card debt. Which is the better choice depends on how much you owe and your credit score.

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Credit cards are amazingly handy tools – they allow you to pay for practically anything in an instant, no checks or cash required, at least not at that moment.

But their utility can quickly morph into a liability if you can’t pay the monthly bill. If you’ve fallen behind and the amount you owe is growing each month, it’s time to make a plan and regain control.

Debt consolidation and credit card refinancing are two of the most common ways to reduce credit card debt. They have the same goal – reducing the amount of debt owed – but take very different roads to get there.

The first, debt consolidation, usually requires getting a loan that can be used to pay off high-interest credit card debt. The loan can be secured, for instance a home equity loan or line of credit, or unsecured, a personal loan that a borrower can obtain from a bank, a credit union or an online lender.

Credit card refinancing, which differs from debt consolidation, is often a simpler strategy for those with good credit. It usually requires getting a credit card that offers a zero-interest balance transfer option with a large credit limit. The card user can transfer debt from other high-interest cards to the new one and not be charged any interest for the introductory period.

Most no-interest balance transfer offers are limited to 12-18 months. After that, the interest rate jumps to whatever the card typically charges, which usually is somewhere between 16%-20%. To make this strategy work, the borrower must be able to pay off the card balance during the no-interest grace period.

Debt consolidation vs credit card refinanceWhat Is Credit Card Refinancing?

Credit card refinancing is a simple way to lower monthly interest payments, but it is, at best, a temporary fix unless you can pay off your debts in the time frame allowed. All you need to do is move balances from your various cards to a single card offering an interest-free grace period, typically 12-18 months. There usually is a transfer fee of 3%-%5 of your balance involved. Sometimes one of the cards you now use will offer interest free periods on balance transfers as a promotion. If that isn’t available, shop around for a card that offers a no-interest introductory rate as an incentive.

What Is Credit Card Debt Consolidation?

Credit card debt consolidation means taking out a loan to pay off what you owe the card companies. It isn’t for everyone. If you have substantial equity in your home, a good credit rating and a steady income, getting a home equity loan should be a fairly easy way to borrow the money to pay off your credit card debt. The second option, a personal loan, is unsecured and might be harder to get. Since unsecured loans pose greater risks to lenders than loans that use collateral, they generally come with higher interest rates, though seldom as high as rates on unpaid credit card balances.

What Are the Pros and Cons of Credit Card Refinancing?

Credit Card refinancing to consolidate debt can work – but a lot of elements have to be in play to be successful. Those include having a high enough balance limit on the new card to put all your credit card debt on it, as well as the ability to pay the card off before the 0% interest rate period ends. And, on top of that, having a good enough credit score to qualify.

If you just want to lower your monthly payment, rather than pay the debt off, you may want to find a lower-interest card to transfer your balances to. If you can switch from a card that charges 21% APR on balances to one that charges 15%, you’ll save money.

Before transferring money to a card with a 0% introductory rate, make sure you consider any balance transfer fees. These are usually 3%-5% and could affect whether it’s a sound financial decision for your budget.

Pros of Refinancing

Moving your balances to a credit card with a 0% interest rate can save you a lot of money if the card has a high enough credit limit to include all your other credit card debts. For instance, if you carry a $1,000 balance on a card that charges 25% annual interest, you would pay $250 a year in interest. Four $1,000 balances would be $1,000 a year in interest. Depending on the rate at which the interest compounds, that can become a serious drain on a monthly basis. But if you pay no interest for a year, you could focus on paying down the principal. If you can’t get a 0% interest promotion, consider transferring your balances to the card you currently have that charges the lowest interest.

Refinancing with a credit card transfer is relatively easy to set up, the upfront cost can be low with the right promotional offer and it will eliminate your balances. You need to make repayment your No. 1 financial priority, which means limiting your credit card use while paying off the balance.

Cons of Refinancing

Will I qualify for a 0% credit card? You’re not the first to ask. It’s the big question for those looking to eliminate or reduce a mountain of credit card debt.

In most cases, you need a credit score above 680 to get an offer. Keep in mind, too, that credit card refinancing isn’t a permanent solution for problems with debt. If you use a 0% interest promotion or introductory rate to aggressively pay off your balances, then it has definite advantages, but if you don’t pay down debt, or you only pay a small amount of it during the grace period, you will once again face high interest.

There is also the temptation to spend more during the no-interest period, which would defeat the purpose.

Unless the promotion or the introductory credit card offer includes a no-fee-on-transfers provision, you will have to pay money to move debt from one card to another. Make sure you know how much the transfer fee is before doing a refinancing. The fee is usually 3% to 5% of the amount transferred, and you want to factor that cost into what you can afford. You also are limited to the credit limit of the card receiving the balance transfers. If you owe $10,000 on several cards and the card you plan to use for refinancing has a credit limit of $8,000, you can’t take care of all  your debts. Still, merging most of your debt on a no-interest card might be advantageous.

What Are the Pros & Cons of Credit Card Debt Consolidation?

Credit card debt consolidation gives you more time to pay the debt off at a much lower interest rate. It’s a great deal for those who have good credit and can commit to making payments every month. It can be trickier, and not a great solution, for those who can’t.

Pros of Debt Consolidation

Lower fixed interest rates, an extended repayment period and a fixed monthly payment are the big pluses of a debt consolidation refinance. Since credit card interest is imposed on the current unpaid balance every month, payments can be high, especially at interest rates that often exceed 20% or 25%. Annual interest rate on a home equity loan can be significantly lower, often in the 5%-8% range, and each month you repay both principal and interest until the loan is repaid. Most lenders let you pay off the loan early if you have extra income available.

Personal loans are another option. These loans often charge origination fees of as much as 8% of the amount borrowed and the interest rate you pay during the repayment period can vary widely based on your credit score and other financial information.

There are advantages: Interest rates will almost certainly be lower than what you’ve been paying on your credit card balances and you will know in advance what the minimum monthly payments will be for the life of the loan, typically around five years. You should shop around before you settle on a lender. Credit unions usually offer the best interest rates, while online lenders might charge substantially more for less-qualified borrowers.

The interest rate is fixed on any debt consolidation loan – that means it won’t change over the course of the loan, and you’ll always know what your payment is.

Both home equity and personal loans simplify your finances. You make one monthly payment, instead of juggling several cards, each with its own balance and repayment date.

Cons of Debt Consolidation

Those who decide to consolidate debt with a home equity loan, a home equity line of credit (HELOC) or a cash-out refinancing of their dwelling, face one big risk. In exchange for a low-interest loan, they put up their home as collateral, which means it could be lost to foreclosure if they can no longer afford the monthly loan payments.

Credit cards are unsecured debt, and you are better off consolidating that debt with an unsecured, or personal, loan. But if you apply for an unsecured loan from a bank, credit union or online lender, you should ask about origination fees, an up-front amount lenders charge to process your loan. You also need to know the annual percentage rate, the time you have to repay the loan and what the monthly payment will be.

If a personal loan still makes sense to you, be prepared for it to take a while to go through processing. Lenders will ask questions about your debts, income, credit score and investments and they will probably want to confirm what you tell them. If you get a loan, you should understand how much it will add to your monthly expenses and refrain from credit card use that would create new balances.

Should You Consolidate Credit Card Debt or Refinance?

Weighing consolidating credit card debt vs. credit card refinancing often turns on timing and what your financial situation is. How long will it take you to pay off the debt if there’s no interest compounded? What is your credit score and what are your assets?

If you can’t imagine paying off a refinanced balance during the grace period, a debt consolidation loan probably is a better option. A consolidation loan allows you to pay off your credit card balances immediately and gives you the convenience of making a single monthly payment over an extended period. Unlike credit card debt, a consolidation loan allows you to pay off your balance within three to five years, or longer if you borrow against your home equity.

Choose Credit Card Refinancing If:

  • You have good credit, particularly a credit score of 680 or higher.
  • You can pay off what you owe on a 0% rate card in the 12-18 month introductory period.
  • You get a high enough balance limit on the card to transfer all your high-interest cards to the new card.
  • Your objective is to lower your monthly payment, giving you a better chance of paying everything off.

Choose Debt Consolidation If:

  • Your credit card debt is too high for you to pay it off in the 12-18 months of an introductory 0% credit card offer.
  • You have a house with equity, and can qualify for a low-interest second mortgage or home equity line of credit.
  • You qualify for a personal loan that makes financial sense, including fees and other costs.
  • You can afford the payment on the loan for an extended period of time – up to five years.

Consider a Credit Counselor

If you owe a lot of money, have a low credit score and/or your finances aren’t right for either credit card refinancing or debt consolidation, you may want to consider talking to a credit counselor at a nonprofit credit counseling agency. A credit counselor can help you create a budget, as well as help you form a strategy to eliminate your credit card debt.

The counselor may suggest a debt management plan, which involves combining your various credit cards into one payment. Counselors are granted interest rate concessions by lenders, and can offer  you a plan where they pay down the balances on your credit cards, and you make one monthly payment to the organization. It usually takes 3-5 years to pay off your debt with a debt management plan, and your payment stays the same for that period.

There is a monthly service fee, and the plan will also be reported to the credit-rating agencies and likely will affect you credit score. Your credit score will drop for the first few months of the debt management plan because you are asked to get rid of your credit cards. The good news is, your score will go back up soon enough, because the credit card companies will receive on-time payments every month.

About The Author

Max Fay

Max Fay has been writing about personal finance for Debt.org for the past five years. His expertise is in student loans, credit cards and mortgages. Max inherited a genetic predisposition to being tight with his money and free with financial advice. He was published in every major newspaper in Florida while working his way through Florida State University. He can be reached at [email protected].

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