Should You Consolidate with a Loan or a Credit Card?

By Jason Ramin

Although using new debt to pay off existing debt can be somewhat counterintuitive, consolidation can sometimes be a valuable tool in your financial toolbox. When done right, consolidating debt can not only simplify repayment by combining multiple debts into a single debt, but it can also reduce the amount of interest you pay on that debt, lowering the cost to become debt-free.

You can technically use any type of financing to consolidate debt, but the two main methods used by most consumers is to consolidate with balance transfer credit cards or to consolidate with a personal installment loan. The best method for your situation will depend on several factors, which we’ll analyze below.

Your Credit Profile

Perhaps the most important factor in deciding how to consolidate your debt is your credit profile, as your credit will be the main thing on which your interest rates are based. Since the main point of consolidating your debt is to reduce your interest rate, you’ll want to go with the method most likely to accomplish that goal. As such, using a credit card may not be the best idea if you have poor credit.

Basically, using credit cards to consolidate debt works best if you can obtain a credit card with a 0% APR offer good on balance transfers — and these offers typically require you to have at least good credit to qualify. So, if you have a fair or low credit score, finding a 0% APR offer will be a challenge. And, outside of maybe the local credit union, poor credit means even finding just a lower rate than you already have will probably be tough.

Moreover, the balance transfer fee that most credit cards will charge to transfer your debt means you need to get a much lower interest rate than you’re currently being charged to make up for the fee, which can range from 3% up to 5% of your total transferred balance. Unless you can get a credit card with a low enough interest rate to make up for the balance transfer fee and still come out paying less than you did before — you may want to go with a loan.

The Size of Your Debt

Another thing to consider when evaluating debt consolidation methods is how much debt you actually need to consolidate, especially if your credit isn’t ideal. The amount of money you can borrow through a personal loan will be based on your credit profile, your outstanding debt, and your monthly income — as will the credit limit you’re offered for a new credit card.

If you’re considering consolidation with a credit card, you’ll need to be sure you can get a card with a credit limit large enough to handle all of the debt you want to consolidate. What’s more, if the credit card charges a balance transfer fee, you’ll actually need a credit card with a credit limit higher than the amount you want to transfer to the card, as the balance transfer fee is charged to your card at the time of the transfer.

In general, the same consumer will likely be offered a larger personal installment loan than they could get from a credit card, as installment loans are inherently less risky than credit cards with revolving credit lines. That said, if you apply for a balance transfer credit card, you can sometimes request a higher credit limit to accommodate a planned transfer.

How Long You’ll Take to Repay

The time you need to pay off your debt should also factor into how you decide to consolidate that debt. Credit card introductory interest rate offers, for example, are just that — introductory. The average 0% APR offer tends to extend just 12 months, then the APR reverts back to the default rate (which will likely be 15% or more).

Any balance remaining on your credit card after the promotional period ends will start accruing interest at the default rate, meaning you’ll need to pay off the balance as quickly as possible at the higher rate, transfer the balance again — and pay a second transfer fee — or consolidate the remainder with a personal loan.

If you know ahead of time that you’ll likely need an extended amount of time to pay off your debt, consider a personal installment loan. Personal loans can have terms that extend up to seven years in some cases, which provides ample time to pay off most debts with reasonable monthly payments. Of course, the downside to taking longer to pay off your debt means you’ll pay more in interest, so be sure to crunch the numbers so you know what to expect.