Balance Transfer or Personal Loan?

If you have debt, you’re likely trying to figure out the easiest way to pay it down. After all, it’s not something you want looming over you forever. Fortunately, there are options out there to help you eliminate your debt, such as balance transfers and personal loans. Choosing a debt relief option can be challenging, but if you understand the nature of your options and the factors influencing your choices, you can adequately make a decision that works best for you.

What are Balance Transfers and Personal Loans?

A balance transfer card takes your existing credit card debt and transfers it to a new card that has a zero percent interest rate for a set period of time. On the other hand, a personal loan is unsecured debt given to an individual to pay off their existing debt. Both options are methods of consolidating your debt into a single loan making it easier for you to manage.

Both balance transfers and personal loans come with varying interest rates and fees. Balance transfers attract customers by offering zero interest for a given period of time. Once that period is over, usually 6 to 12 months, an interest rate will be introduced indefinitely which can be higher than your existing credit card interest rates. Personal loans always have interest rates, however, the interest rates can be lower than credit cards depending on your financial situation.

Balance transfer cards have a one-time transfer fee based on the total debt being transferred as well. Judgment should be exercised to determine if the transfer fee is worthwhile based on the offer you got with the balance transfer card.

How to Choose Between a Balance Transfer and a Personal Loan

Balance transfers and personal loans have their own unique advantages and disadvantages. Those advantages and disadvantages can work in your favour, so long as you analyze your situation to determine the best option for yourself. Be sure to fully understand your finances before considering the factors below in order to make the best decision possible.

Interest

As mentioned, balance transfers usually have zero interest rates to attract new customers, but only for a limited time. Once the introductory period has passed, an interest rate will be introduced which is typically higher than interest rates you have on existing credit cards. In fact, interest rates can be especially high if the individual has a good credit score.

Click here to learn how lenders arrive at interest rates.  

Another factor to consider with balance transfer cards is the duration of the interest-free period. If your total debt can be paid off reasonably within the interest-free period, the card may be an ideal option for you. If your total debt is too high to pay off during the zero-interest period, consider using a balance transfer card to pay off your debt with the highest interest or another portion of your debt.

With personal loans, there will be an interest rate no matter what your situation is. If you have good credit, you’ll be able to find personal loans with lower interest rates, hopefully in the single digits. Keep in mind that interest rates for personal loans can range anywhere between 5% and 36% and the average rate for credit cards is around 17.5%. If you can find a personal loan with a lower rate than an average credit card, you may benefit more from a personal loan with lenders like Borrowell.

Origination Fee

Online lenders for personal loans tend to charge a loan origination fee which is a one-time charge taken from the total loan amount received by the debtor. Origination fees can be anywhere up to 6% of the total loan amount and the fee is included in the loan’s annual percentage rate calculation.

Typically, banks and credit unions do not charge an origination fee for personal loans. Be sure to read the fine print of personal loan agreements before signing to fully understand the fees you will incur.

One-Time Balance Transfer Fee

Most balance transfer promotions require a one-time fee which costs around 3% to 5% of the total debt being transferred. The one-time fee for a balance transfer can be compared to the interest cost of a personal loan.

If the balance transfer fee is cheaper than the interest on a personal loan for a given period, the balance transfer card is the better option. Of course, this works the other way too.

Type of Debt

Balance transfer cards sometimes restrict certain types of debt from being transferred to the new card. Typically credit card debt is transferable, although, student loans, auto loans, and mortgages are not. When making your choice, be sure to look at all the debt you have and whether or not it could be restricted.

Trying to consolidate your credit card debt? Read this first.

Personal loans don’t restrict what debt the new money can be applied to. Usually, the new money is deposited into your account and you can choose where it goes. If you have debt that will be restricted by balance transfers, personal loans are definitely an ideal option.

Credit

A utilization rate is the amount of available credit that you have on your credit cards. Low utilization rates are favourable when calculating your credit score.

By opening up a new account for the balance transfer card, you will probably push the utilization ratio on the new card to a percentage just shy of 100% which can have a negative impact on your credit score. However, it depends on the amount of debt you’re transferring and the approved credit limit on your new balance transfer card. If you move a small amount of debt to a card with a large limit, your utilization ratio could actually decrease. Also, credit scoring models take into account activity related to moving debt from one card to another, which could cause your score to fall even lower.

With personal loans, your utilization rate could drop closer to 0% leading to a better credit score. Even though either way you aren’t eliminating debt, just moving it around, the credit scoring models take preference to personal loans over balance transfers.

Credit Inquiries

Whenever you open a new account, including balance transfer cards and personal loans, the lender will likely check your credit which will appear on your report as a hard inquiry that can negatively affect your credit score. Hard inquiries remain on your credit report for around two years but impact you the most in the first year.

Mix of Credit Types

Having a mix of credit types can positively impact your credit score. Loans and credit cards are different types of credit which will be reflected in your score. It is important to note that too many lines of credit can be perceived negatively by future lenders. Make sure that you don’t take on debt that you can’t handle effectively.

Payments

Finally, how you manage your new balance transfer card or personal loan is an important factor in your credit score calculation. As with all other debt, missed payments or frequent minimum payments are never great for your credit score.

Payment Schedules and Fixed Rates

The nature of personal loans requires that the debtor make regular, predictable payments based on a fixed interest rate and a set payoff date. Because the payments are set ahead of time, personal loans can help those who struggle with their spending habits stay on schedule and budget. Although not everyone wants the commitment of a monthly loan payment, some may prefer the variability in monthly payments that come with a credit card.

Click here to learn how your payment history changes your credit score.

With a credit card, the payments must be determined and managed entirely by the cardholder. If it isn’t managed properly, the individual will end up paying more for an extended period of time when compared to a personal loan. That being said, those who don’t struggle with their spending habits and enjoy financial flexibility may prefer balance transfers.

Final Thoughts

There are a lot of factors to consider in your debt consolidation decision. It’s important to remember that everyone’s debt situation is unique, you need to look at your offers, costs, total debt, and personal preferences among many other factors to determine if balance transfers or personal loans are ideal for you.

If you are having difficulty deciding between a balance transfer and a personal loan, Loans Canada can help.