Should You Consolidate Credit Card Debt or Refinance?
The answer comes down to timing. Credit card refinancing can be handled on your own, but if you need help consolidating your debts, we can assist in that.
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Credit cards are amazingly handy tools that allow you to pay for practically anything in an instant, no checks or cash required, at least not at that particular moment.
But their utility can quickly morph into a liability if you’re unable to 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.
Consolidation and refinancing are two of the most common ways to reduce credit card debt. 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 a 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 is often a simpler strategy for those with good credit. It usually requires getting a credit card offering 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.
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.
What Is Credit Card Debt Consolidation?
Debt consolidation 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 obtain. 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.
Here are points to consider before seeking a consolidation loan.
Pros of Debt Consolidation:
Lower, fixed interest rates and an extended repayment period are the big pluses. 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 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 borrower. Credit unions offer the best interest rates, while online lenders might charge substantially more.
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 for some reason 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.
What 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 quickly. All you need to do is move balances from your various cards to a single card offering an interest-free grace period, typically 12 to 18 months. 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.
Pros of Refinancing:
Moving your balances to a credit card with a 0% interest rate can save a great deal if you are given a high enough credit limit to include all your debts and can pay it off in the time from allowed. 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 and avoid interest payments in the future. If you can’t get a 0% interest promotion, consider transferring your balances to the card you currently have that charges the least interest.
Cons of Refinancing:
The big question about 0% interest cards is: Will I qualify?
In most cases, you need a credit score above 680 to get an offer. Also, remember that credit card refinancing isn’t a permanent solution for 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, you will once again face high interest when the grace period ends.
There is also the temptation to add even more to the balance 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 might also have to pay money to move debt from one card to another.
Make sure you know how much the transfer fee, which is often 3% to 5% of the amount transferred, before doing a refinancing. 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 completely combine your debts. Still, merging most of your debt on a no-interest card might be advantageous.
When to Consolidate and When to Refinance
Weighing consolidating credit card debt vs. credit card refinancing often turns on timing. If you have enough income and are willing to curtail spending to pay off your debts within a year or 18 months if the interest rate goes to 0%, then refinancing is your best option.
It’s 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 balance repayment your No. 1 financial priority, which means limiting your credit card use while paying off the balance.
Refinancing might also work if your objective is merely to lower your monthly payment. If you switch from a credit card that charges 21% APR on balances to one that charges 15%, you’ll save money. Before transferring money, make sure you consider any balance transfer fees.
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 time 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.
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