If you have severe credit card debt and a high interest credit card, you're stuck in a never ending cycle of minimum payments and more debt. There are a few ways to get out of this hole you've dug yourself into -- credit card refinancing or debt consolidation.
On the surface, it seems that they both accomplish the same goal. To some degree, that may be true. But how they do it can be very different. For that reason, if you're considering either, you should decide what's most important -- getting a lower interest rate, or paying off your credit cards.
What is credit card refinancing?
Credit card refinancing, also known as a balance transfer, is simply a process of moving a credit card balance from one card to another that has a more favorable pricing structure.
This can also mean moving a $10,000 balance on a credit card that charges 19.9 percent interest, over to one that charges 11.9 percent. Many credit card companies also offer cards with a 0 percent introductory rate as an incentive for you to move a balance to their card.
In such a situation, you can save eight percent per year, or $800, by moving a $10,000 balance -- just based on the regular interest rate. But if the same credit card has a 0 percent introductory rate for 12 months, you'll save nearly $2,000 in interest just in the first year.
Credit card refinancing is, more than anything else, about lowering your interest rate. It tends to be less effective than debt consolidation at getting out of debt, since it really moves a loan balance from one credit card to another.
What is debt consolidation?
Generally speaking, debt consolidation is about moving several credit card balances over to a single loan, with one monthly payment. Consolidation can sometimes be accomplished by moving several small credit card balances over to one credit card with a very high credit limit, but it's more commonly done through the use of a personal loan.
Personal loans are typically unsecured, but offer a fixed interest rate, fixed monthly payments, and a very specific loan term. That means that you'll have the same monthly payment - at the same interest rate - each month, until the loan is full repaid.
If you're looking to eliminate credit card debt, debt consolidation is usually a more effective strategy than credit card refinancing. This is because a debt consolidation loan is paid off at the end of the term, while credit card refinancing keeps you in a revolving payment arrangement, in which there is potentially no end.
The advantages and disadvantages of credit card refinancing
Advantages
0 percent interest rate on balance transfers - credit card lenders frequently make offers in which they will provide an interest-free credit line for a specific amount of time, usually six months to 18 months after a balance is transferred. As described above, this can result in a substantial temporary savings in interest expense.
Quick application process - Whereas personal loan applications may take a few days to process and require paperwork to verify your income, a credit card application is typically a single online form and, in most cases, you'll get an decision within a minute or two.
You're replacing one credit card debt with another at a better interest rate - the most tangible benefit of a credit card refinance is getting a lower interest rate. This can take place either in the form of the temporary 0 percent introductory rate offer, or through a lower permanent rate.
Your credit line can be re-accessed as it's paid down - since credit cards are revolving arrangements, any balance that you pay off can be accessed later as a new source of credit. Once the line has been paid off completely, you will have access to the entire balance once again.
Disadvantages
0 percent interest rate will come to an end - as attractive as a 0 percent introductory rate is, they always come to an end. When they do, the permanent rate is usually something in double digits. It's even possible that the permanent rate will be higher than what you currently paying on your credit cards.
Variable interest rates - unlike debt consolidation loans that have fixed rates, credit card refinances are still credit cards, and therefore carry variable rates. The 11.9 percent rate that you start out with could go to 19.9 percent at some time in the future.
Balance transfer fees - this is a little known fee that's charged on nearly every credit card that offers a balance transfer, particularly with a 0 percent introductory rate. The transfer fee is generally three to five percent of the amount of the balance transferred. That could add as much as $500 to the cost of a $10,000 balance transfer.
You may never pay off the balance - since credit cards are revolving arrangements, there's an excellent chance you'll never pay off the balance. That's because, at a minimum, your monthly payment drops as your outstanding loan balance falls. This is why credit card refinancing is usually not the best way to eliminate credit card debt.
The advantages and disadvantages of debt consolidation
Advantages:
Fixed interest rate - though it's possible for personal loans to have variable interest rates, most have fixed rates. This means that your rate will never go up.
Rate may be lower than what you're paying on your credit cards - in many cases, particularly if you have strong credit, you will pay a lower interest rate on a personal loan than you will on your current credit cards. It's possible to get personal loan rates in single digits.
Fixed monthly payment - this means that your payment will remain constant until the loan is fully paid.
Definite payoff term - personal loans carry a fixed term, and at the end of that term, your debt will be fully paid. This is why debt consolidation using personal loans tends to be a more effective way to pay off revolving debt than a credit card refinance.
Disadvantages:
Payment never drops - for example, if you're paying $400 a month on a $10,000 loan, the payment will still be $400 when the balance has been paid down the $5,000.
Origination fees - personal loans typically don't have balance transfer fees, but they do have origination fees that function in much the same way. Depending on your credit, they can range between one and six percent of the new loan amount.
More involved application process - personal loans usually require a formal application process. That will include not just a credit check, but also that you supply documentation verifying your income and even certain financial assets.
Might set you up to run up your credit cards again - one of the hidden dangers in any debt consolidation arrangement is the possibility that you may use the consolidation to lower your monthly debt payments, but then run up the credit cards that have been paid off.
Which is right for you?
If you're mostly looking to lower the interest rate you're paying on your current credit cards, credit card refinancing may be the better choice. Just be careful not to be too heavily focused on a 0 percent introductory interest rate offer. That only makes sense if the permanent interest rate on the new credit card is also substantially lower than what you're paying on your current credit cards.
If your primary interest is in paying off your credit card balances completely, then a debt consolidation using a personal loan will be the better choice. The fact that personal loans have fixed terms -- usually three to five years -- makes it more likely you'll get completely out of debt.
Whichever route you choose, carefully evaluate the interest rate and fees on the new loan, and never ever, ignore the fine print!
Comments
Post a Comment