America is being crushed under a mountain of debt. According to the Federal Reserve, consumer debt is at an all-time high of $4 trillion, out of which credit card debt is more than $1 trillion. However, according to https://www.forbes.com, Americans seem to have realized the dangers of uncontrolled credit card debt and are taking action to keep their card debt under control. It quotes a study that reports that around half of Americans are operating within the maximum limit of their cards and as much as 38% of those with card debt have used balance transfer as a method of debt consolidation. While it is true that balance transfer is a popular mechanism to eliminate debt, debt consolidation loans are also in vogue. While both methods result in lower interest expense enabling you to get on top of your debt problem faster, most people are confused about the pros and cons of each and therefore, unable to make an informed decision. Some useful insights:
Credit Card Balance Transfers
A credit card balance transfer is typically a promotional offer by the credit card issuer to get more people to subscribe to the card and quickly acquire debt on its books that will generate revenues in the future by way of interest and other fees. The zero percent balance transfer offer is, however, restricted to only those with good credit. You can expect to get up to 24 months during which all your card balances will not attract any interest. This represents a very good opportunity for people to save substantially on the interest.
Balance transfers are extremely popular with people who are stressed out due to the high credit card interest rates because eliminating the interest allows them to stop bleeding temporarily and allocate the full amount of each payment toward debt reduction. However, it is vital to know and understand the terms of the balance transfer offer.
Customers with good credit get the best balance transfer offers that may include a zero percent interest rate. Regardless of what the advertisements may say, you should find out what your card issuer is prepared to offer after reviewing your application. Even if you do get a zero percent offer, check the period of the offer and find out what the rate will be after the promotion ends. Some cards may require you to pay off your balance in full during the promo period otherwise; they will charge deferred interest that will derail your goals, according to a NationaldebtRelief.com credit counselor.
It is normal for the credit card issuer to charge a balance transfer fee of around 3% of the amount being transferred or a flat dollar fee, whichever is more. Since the fee adds to your cost, you have to ensure that the savings from switching to a lower rate of interest are still worthwhile. You also need to bear in mind that you may have to pay annual fees on the new card.
Impact on Credit
Even though by itself a balance transfer does not negatively impact your credit score, applying for a new card can have a minor impact because of card issuers making inquiries on your credit history. However, there can be a slight beneficial effect because of the reduction in the credit utilization ratio as long as you do not use your other cards or close them.
Debt Consolidation Loans
It is also possible to use some kind of a personal loan to consolidate your debt if you are not able to get a zero percent balance transfer offer. These loans are typically available from banks or private lenders as unsecured loans or you may wish to use your home equity to avail of the funds, in which case the rate of interest becomes lower due to the available collateral. Debt consolidation loans make better sense when you need a longer period to pay off your debt because balance transfer offers at zero or concessional rates of interest last for only a few months.
The rate of interest that you will need to pay on a debt consolidation loan depends on several factors; your credit score, the stability of income, and the type of the loan. A typical unsecured personal loan will be costlier than a home equity loan or line of credit that is secured with your home as collateral. However, given the very high APRs of credit cards, the rate of interest even on unsecured loans for people with good credit should provide substantial savings. A zero percent balance transfer offer by a credit card can give you more savings, however, they are relatively harder to obtain and the promotional offer is for a limited period that may not be sufficient to pay off your debts. The rate of interest is fixed for the loan tenor makes it easier to budget.
Some lenders charge processing or origination fees for debt consolidation loans while others just build in everything into the interest rate. It is better to compare the APRs of various lenders so that you can make a better choice.
Impact on Credit
Making inquiries with lenders for debt consolidation loans can hurt your credit score temporarily just like applying for a credit card. However, debt consolidation loans are better for your credit score because it helps to diversify the mix of debt. Applying for a debt consolidation loan for repaying credit card debt sends out the right signals that you are committed to paying down your debt using the right kind of funds and this behavior is likely to be continued for future financial transactions. Your credit will continue to improve as long as you keep on making the repayments on schedule.
There are no clear winners between a balance transfer and a debt consolidation loan for reducing your debt. If you are confident that you will be able to repay our entire debt within the 0% interest rate promotion period, you will be able to achieve the maximum savings; however, if you require a longer period, a debt consolidation loan would be better suited.