Debt consolidation loans vs. 0 percent balance transfer cards – which is the best way out of debt?

The new year is celebrated as a time of fresh starts. If you have high balances across multiple cards, though, you might feel shackled to the past.

There are two often-touted shortcuts out of this quagmire:debt in new year

  1. Debt consolidation loans: You’ll apply for a personal loan from a bank, or via a peer-to-peer loan service (Prosper, for example). For the purposes of this article, we’ll be talking unsecured loans, but you can also get a secured loan (a home equity line of credit, for example). If approved, you’ll use the loan proceeds to pay off your cards. Then, you’ll pay off the loan (which, hopefully, has a lower APR than your card balances).
  2. 0 percent balance transfer cards: You’ll apply for a card that has a 0 percent balance transfer period (which will generally range from 12 to about 20 months). When you apply (or after you’re approved), you’ll tell the new card’s issuer which cards you wish to pay off. Your new issuer will do so on your behalf, thus transferring your balances to the new card. During the 0 percent period, you’ll pay no interest on your debt. After that, your APR will depend on the issuer and your creditworthiness.

Simple math would seem to indicate that getting a 0 percent card is the way to go, but not necessarily. The smartest path out of debt depends on your history and your habits.

Your credit history

Both 0 percent balance cards and personal loans are unsecured debt, meaning the lender is taking a risk. If your credit is poor, you chance being turned down for both, but there’s a key difference in the application process: With personal loans, you generally choose the amount of the loan up front. You may not like the interest rate, but, if you’re approved, you’ll at least have enough to cover your balances. Going for a 0 percent balance transfer offer, however, involves applying for a card – and you have no idea what your limit will be. Imagine your frustration if you’re approved for a card with a 15-month 0 percent period – but you get just a $2,000 limit and have $10,000 in debt.

“This is where you can get stuck between a rock and hard place,” says Rod Ebrahimi, CEO and co-founder of debt-reduction site Ready for Zero.

Which option? If your credit is iffy, your debt is high and you want to consolidate all of it, the loan is probably the way to go. If you have excellent credit and a smaller amount of debt, consider 0 percent offers.

So you’re not flying blind, there are several tools available that will soft-pull your credit (that means no credit damage) to let you see which offers you’re eligible for. For balance transfer cards (and cards in general), there’s CardMatch. Check your mailbox, too, to see if you have any preapproved offers. For loans, Ready for Zero has a loan-shopping tool, and many lenders/peer-to-peer loan services will let you perform a soft inquiry to see what you might qualify for.

The kinds of debts you have

When you get a personal loan, the money goes into your account, and you can use it to pay off cards and other loans. Balance transfer cards may come with more restrictions. You may not be able to use them to pay off loans, for example, and many issuers do not allow you to transfer balances from their own products (see the Chase Slate’s fine print below):

Chase BT terms

Which option? Loans will generally give you more flexibility. If you want a balance transfer card, read the fine print and make sure all your debts are eligible for transfer.

How organized you are

The process is a bit more streamlined with balance transfer cards. You’ll share the account numbers of the debts you wish to transfer, and, assuming your limit covers them, your new card will automatically pay them off (although it may take up to a couple weeks). With a loan, you get the money and must pay off your balances yourself.

Which option? If you’re financially scatterbrained, you might find the balance transfer card a better fit. That way, you won’t find yourself getting the loan proceeds and letting them sit in your account until you get around to paying off all your other accounts.

Your discipline

Successful debt payoff often boils down to picking the technique that keeps you on track and motivated – not the one that may cost you less in the best-case scenario.

Personal loans have a term, an official end date and a fixed payment due. This means they offer structure that cards don’t. With a balance transfer card, the only hard and fast rule is making the minimum payment, which will likely not zero out your balance by the time the 0 percent period expires.

There’s another issue with cards: Unlike a loan, you can use the card for additional purchases. This gives you two balances (the transferred balance at 0 percent and the new-purchase balance at whatever your card’s APR is), which can make you lose focus.

“Maybe you transfer $10,000 and then go to Starbucks and use that same card,” Ebrahimi says. “That $5 at Starbucks might have a 15 percent rate. They’ll separate it into the transferred balance and new purchases. It’s super confusing to people.”

Which option? If you’re disciplined enough to wipe out all your debt within a card’s 0 percent period, or you have a small, manageable amount of debt, paying your debt off at 0 percent beats paying it off whatever APR you’d get on a loan.

“A lot of people play this 0 percent game,” Ebrahimi says. “But the ones I know who have been able to save a significant amount of money are people who are not just super disciplined in paying it off, but who aren’t transferring a whole ton either.”

If your balances have been building up over years, however, you might have to admit it will take just as long to pay them off.

“It took you five years to accumulate that, and now you want to pay it off in 12 months?” Ebrahimi says. “… A debt consolidation loan is over a longer period, generally two to five years, so that’s probably a more realistic goal.”

Other things to consider

As with any financial product, 0 percent balance transfers and debt consolidation loans come with of fine print – and fees:

  • Balance transfer fee (balance transfer cards): Often, this will be 3 percent of the transferred balance, and it is very rarely waived.
  • Closing or origination fee (loans): This will generally be a percentage of the loan and will be deducted from the proceeds when you get the money. So, if you need $10,000 to cover your balances and the card charges an origination fee of 3 percent, apply for $10,309.27.
  • Prepayment fee (loans): Some lenders will charge you a fee for paying off the principal early (because the lender will be making less money in interest). Fortunately, not all loans do this.

In addition to the costs above, don’t forget to consider that none of this may be necessary. Before pursuing any get-out-of-debt shortcuts, see if your current card will offer you a lower APR. That lets you avoid extra fees, the additional credit pull for applications and the hassle of moving your balances.

Having a lengthy on-time payment record and offers in hand from other lenders will help your case.

“You might say, ‘Can you give me a break? I’ve been paying on time for the last eight months,'” Ebrahimi says. “The reason the 0 percent offers exist is because they’re competing for your business. So call your current card company first.”

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I meant to say that my revolving credit is around 3500 and my FICO score tells me I need more credit then just credit cards.