If you’ve spent some time researching ways to reduce your credit card debt, you’re probably somewhat familiar with the terms debt consolidation and credit card refinancing. Maybe you’ve seen them mentioned before, but you’re still unsure of the differences between the processes or what option would work best for your financial situation.
You came to the right place! In this article, we’ll define refinancing and consolidation, explain their differences, and suggest the process and products that could be the smarter financial move depending on your circumstances. Before we cover that, let’s get a bit of background on both of these popular debt payback methods.
A bit of background
Debt consolidation and credit card refinancing are two of the most common ways people go about decreasing, managing, and paying back their credit card debt.
Sometimes the terms are used interchangeably, and understandably so – the goals of refinancing and consolidating high-interest debt are essentially the same. Lower interest rates, lower monthly payments, and all-around better terms for your debt.
To add to the confusion, the processes aren’t mutually exclusive – meaning you can both refinance and consolidate your debt at the same time.
To make things simpler, think of the primary difference between the two processes as this:
- The aim of refinancing is to optimize your existing debt by replacing it with another debt that has better terms.
- The aim of debt consolidation is to turn many debts into a single debt, saving you money and eliminating the stress of having to make multiple monthly payments.
The option that’ll work best for you ultimately depends on your financial situation, so keep that in mind while reading.
Let’s begin by taking a closer look at credit card refinancing.
What is credit card refinancing?
Credit card refinancing describes the process of moving high-interest credit card debt to another credit card or loan with lower rates. Moving your balance to a card or loan with lower rates could save you money on interest, allowing you to put more money towards your debt and pay it off faster.
How does credit card refinancing work?
There are two common financial tools borrowers use to refinance their credit cards: balance transfer credit cards and personal loans. First, we’ll walk through a brief step-by-step process on how refinancing works. After that, we’ll share a bit more about each product and their various differences.
Here’s the step-by-step process for how refinancing works:
- You apply for a balance transfer card or personal loan with a lower APR than your current debt and get approved
- You use your new card or loan to pay off your old card’s balance, which transfers the balance to your new financial product
- You chip away at your debt by making monthly payments on your new, refinanced balance
Sounds fairly straightforward, right? So why would you choose one refinancing product over the other? Let’s take a closer look at the details.
Refinancing with a Balance Transfer Credit Card
Balance transfer credit cards usually come with a lower interest rate, often 0%, for a given period of time – typically 12 to 18 months. If you qualify for a 0% APR balance transfer card, you can use it to pay down your existing debt without accruing any interest whatsoever (until the promotional period ends.)
Unfortunately, not everyone will qualify for a 0% APR balance transfer card. You’ll typically need a good to excellent credit score to qualify for one, so set your sights for a score around the 670+ range if you’re not there yet.
Read More: 6 Tips for Building Your Credit
With that said, any card with a lower rate than your current one could save you money on interest, so don’t get discouraged if you don’t think you’ll qualify. Here’s an example of refinancing with a 0% APR card and a 10% APR card so you can get an idea of what you could potentially save.
How much could I save by refinancing?
So, let’s say you have a balance of $10,000 on a credit card that has an APR of 25%. You were just approved for a new card that offers a 0% APR for 12 months, so you decide to pay off your $10,000 balance with it. Good move – those interest payments would’ve gotten costly.
By transferring your balance to the 0% card, you could save around $2500 on interest in the first year alone.
But what if you couldn’t get approved for a card with a 0% APR? If 10% was the lowest rate you qualified for, would refinancing still be worthwhile? Even with an APR of 10%, you could still save up to $1500 in one year by simply transferring your balance.
Before you decide a balance transfer card is right for you, keep in mind that these are the highest possible savings amounts. Once you factor in fees, your savings could drop considerably.
Typically, balance transfers come with a fee that’s anywhere from 3-5% of the transferred balance. So, if you’re refinancing a card with a $10,000 balance, you can expect to pay $300 to $500 to complete the transfer.
Be sure to weigh your potential savings against the cost of the fee. Depending on how much you could save, a $500 fee could be the difference between whether or not refinancing with a balance transfer is the smarter financial move.
If your credit is strong enough that you’ll likely qualify for most balance transfer cards, something else you’ll have to consider is the credit limit. For example, if you’re trying to refinance $15,000 worth of debt but only qualify for a $10,000 credit limit, you won’t be able to refinance everything.
In some cases, you may not be able to transfer all of your debt even if it’s equal to your credit limit. Depending on the card, your maximum transfer amount could be 70 – 100% of your approved credit limit – meaning even if you have a $10,000 credit limit and $10,000 of debt, $7,000 is the most you could refinance.
This doesn’t mean you shouldn’t take advantage of the offer if you qualify – you can still save a lot of money on interest this way. Just understand that you may not be able to refinance all of your debt with a balance transfer credit card.
Timeframe and rate changes
If you transfer your high-interest debt to a card with a low or no-interest APR promotional offer, remember that the low-interest period usually only lasts 12-18 months. After that, your rates will hike back up – and whatever balance is on the card will start accruing interest, fast.
Balance transfer cards also have a variable interest rate, meaning once the promotional period ends, the amount you pay in interest can change month to month. This isn’t necessarily a bad thing – some months you may save on interest, others you may have to spend a bit extra.
Now that we’ve thoroughly covered refinancing with a balance transfer card, it’s time to talk refinancing with a personal loan.
Refinancing with a Personal Loan
Refinancing credit card debt with a personal loan is simple. You take out a loan with lower rates than your current card, use the funds to pay off your credit card balance all at once, and make payments to your new lender instead of to your credit card company.
We’ll briefly review the same details we did for balance transfer cards so you can quickly compare and contrast the two products.
Similar to balance transfer credit cards, your financial history and credit score play a significant role in the rates you qualify for and whether or not you’ll be approved. Depending on the lender and your financial history, personal loan interest rates can range from 6% to 36%.
Obviously, the higher your score, the better rates you’ll likely qualify for – but you’ll typically want a score of 660+ to qualify for competitive interest rates. The lower your rate, the more money you’ll save on interest.
Again, your financial history and credit score will be a factor here, but you may be able to pay off more of your debt with a personal loan compared to a balance transfer card. As we mentioned earlier, balance transfer credit cards usually have a maximum transfer limit of 70 – 100%, while personal loans have no such limit, often offering loan amounts from $2,000 – $35,000. Whatever loan amount you qualify for can be used to pay down your debt (minus any additional costs or fees, of course.)
The most common fee you’ll come across with personal loans is an origination fee, which typically ranges from 1% – 8% of the loan amount. It’s a one-time fee you usually pay when you first receive your loan, though some lenders may add the fee to your balance.
If your loan does have an origination fee, it could be worth paying if the APR is lower than your other loan options. In other words, just because a loan has an origination fee doesn’t mean it’ll always be the more expensive option.
If you have one loan with an origination fee of 3% and an APR of 10%, and another loan with no origination fee but an APR of 18%, it could still make more sense to move forward with the loan that has the origination fee.
Read more: What is an Origination Fee?
Timeframe and rate changes
If you seek out a personal loan to refinance your credit card balance, you’ll typically have 3 to 5 years to repay your debt in full. For borrowers who would prefer to have a longer time to pay back their debt, personal loans could be the wiser choice when compared to balance transfer cards.
Unlike balance transfer cards, personal loans offer a fixed rate option – meaning your monthly payment will never change over the course of your loan. While personal loans don’t offer a 0% APR promotional period, a major benefit is that you’ll never have to worry about your rates skyrocketing.
Refinancing with a personal loan offers predictability and certainty, while balance transfers provide low to no-interest rates for a given period of time. If you’re still trying to decide which refinancing product is better for you, this next section could help clear things up.
When refinancing with a balance transfer card makes sense
You have the income to pay off your balance within 12 – 18 months: The main benefit of using a balance transfer card is that you can tackle your debt while paying little-to-no interest during the promotional period. If your debt is manageable enough that you can pay it off before the period ends, you could easily save hundreds to thousands on interest.
You won’t be tempted to keep spending: Self-control’s important here, because nothing’s stopping you from swiping your card and racking up more debt. For refinancing with a balance transfer card to be effective, you’ll want to avoid adding many (if any) charges to your balance. Sticking to a detailed debt reduction plan is highly advised for helping you stay on course.
Read More: 4 Steps to Making a Debt Reduction Plan
The fees won’t greatly impact your savings: Depending on the amount of debt you transfer and the rates you qualify for, the balance transfer fee could be a minimal expense or a major one. Remember, refinancing with a 0% APR card will save you the most money on interest (as long as you pay off the balance before the promotion ends).
When refinancing with a personal loan makes sense
You need more time to pay off your debt: Personal loans usually have repayment terms of three to five years, so if you’d prefer to tackle your debt at a lower rate over a longer timeframe, consolidating could be the choice for you – especially if your current monthly payments are too costly.
Some personal loans come with no prepayment penalties, meaning you can pay off your balance early if you have the means. So, even if you agree to pay your loan back over 5 years, there’ll be no penalties for paying it off in 3.
You’d prefer a structured pay off plan: Unlike refinancing, consolidating your debt gives you a structured payoff plan to stick to. You pay your lenders the same amount, month after month, until your debt is finally paid off. If you prefer structure and predictability when it comes to paying down your debt, refinancing with a personal loan may suit you better.
Alright! Now let’s talk a bit about debt consolidation. We’ll keep this last section short, because there aren’t many significant differences between using a personal loan for consolidation and using one for refinancing.
A quick recap before we move on
Remember, the aim of refinancing is to optimize your existing debt by replacing it with another debt that has better terms. The aim of debt consolidation is to turn many debts into a single debt.
What is debt consolidation?
In general, debt consolidation describes the process of moving multiple debts over to a single loan. The loan can be unsecured like your typical personal loan, or it could be secured like a home equity loan.
Read more: Secured vs Unsecured Personal Loans
The main goal of consolidation is to decrease the number of payments you have to make each month, but as you’ll see from this next example, consolidating could even help you save a decent amount of money on interest.
How does debt consolidation work?
Let’s say you have two credit cards – both have an APR of 25% and balances of $5,000. You qualify for a $10,000 personal loan with an APR of 15%, so you accept the offer and use your new funds to pay off your credit card debt. (Just so you know, this example doesn’t take potential fees or additional costs into account.)
Now, instead of having two credit card payments to keep up with, you only have to make one payment a month – and at a much lower rate. As you can imagine, the more credit cards you have, the greater peace of mind consolidating them into one simple monthly payment can give you.
Should I refinance or consolidate my credit card debt?
If you’re tired of constantly juggling multiple payments with varying interest rates, you may benefit from consolidating your many expenses into one monthly payment with a debt consolidation loan.
If you’re only trying to pay off one credit card balance at a lower rate, refinancing could be the right choice for you.
Whichever route you decide, make sure to closely compare your potential savings with a balance transfer card vs. a personal loan. The more you shop around, the more likely you are to save big on interest and pay down your debt once and for all.