Personal Loan or Balance Transfer — Which Is Better for Consolidating Debt?

If you’re paying high interest rates on loans and credit cards, you might wonder if consolidating them can help you save money and eliminate your balances faster. But what’s better, taking out a personal loan or using a balance transfer credit card?

We’ll review the pros and cons of each, so you know the best strategy to consolidate your debt and improve your finances as quickly as possible.

Pros for consolidating debt with a personal loan

A personal loan is money you borrow to pay for almost anything, such as a dream vacation, education expenses, or debt consolidation. Here are the primary benefits of taking out a personal loan for debt consolidation.

You have fixed repayment terms. A personal loan comes with a specific interest rate and term, so you pay it monthly over a set period. For instance, you might pay 8% for five years with monthly payments of $700. Having a predictable monthly payment helps you manage your budget.

Consolidating multiple balances into one loan payment simplifies your finances because you only need to keep track of one bill due date instead of several. You can focus all your effort and attention on making that loan payment, counting down the months until your debt gets wiped out.

You pay a lower interest rate. Consolidating debt with a personal loan makes sense if you get a lower interest rate than you currently pay. That allows you to reduce your monthly interest expense and get out of debt faster. Let’s say you have a $15,000 balance on two credit cards. If one charges 26% interest and one charges 23%, paying them off with a personal loan that charges 10% saves money.

You can use the funds for any purpose. Using a personal loan gives you the most flexibility if you have different types of debt to consolidate — such as credit cards, auto loans or medical bills. You receive a lump sum in your bank account that you can use to repay any lender, merchant or service provider.

You can build credit. An additional installment loan helps you build credit if you make timely payments. Plus, using it to pay off credit cards can boost your credit scores by reducing your utilization rate, which is the percentage of available credit you use on revolving accounts (such as credit cards and other lines of credit).

Although applying for a new loan may temporarily ding your credit after the lender’s hard inquiry on your credit reports, having a mix of credit types and a lower utilization rate benefits your credit over the long term.

Cons for consolidating debt with a personal loan

Here are the main downsides of using a personal loan for debt consolidation.

Your monthly payment may be higher. Unlike a credit card, where you can make a minimum payment, you must remit the full monthly payment with a personal loan. Having a fixed repayment term means your monthly payment will likely be higher than a card’s minimum payment. The payment amount depends on how much you borrow, the interest rate, and loan length.

If you don’t make timely payments on a personal loan, it can significantly hurt your credit. So, choose an affordable repayment term when you take out a personal loan.

You pay fees. Personal loans charge fees that depend on your lender, amount borrowed, income, and credit. You typically must pay an origination fee ranging from 1% to 5% of the loan amount. There may also be an application fee or a charge to pay off the loan early. Shop and compare offers from multiple lenders to get the best deal possible.

You may rack up card balances again. You may go deeper in debt if you use a personal loan to pay off credit cards but continue charging and accruing balances. So, use consolidation as a fresh start and only make credit card charges that you can pay off in full each month.

Pros for consolidating debt with a balance transfer

A balance transfer credit card gives you an incentive, such as 0% interest during a year-long promotional period, to pay off a balance on another account, such as a credit card or loan. Here are two main benefits of consolidating debt with a balance transfer.

You don’t pay interest. Skipping interest for a period is the best benefit of a balance transfer offer. The promotion varies by card issuer but typically lasts from six to 12 months. You can focus on paying down your transferred balance without any interest accruing during the promotional period.

You can build credit. Getting a new balance transfer card or an additional limit on an existing card raises your available credit, which reduces your credit utilization and boosts your credit scores.

Like adding an installment loan to your credit history can temporarily ding your credit, the same is true when you get a new balance transfer credit card, but the long-term benefits can be well worth it.

Cons for consolidating debt with a balance transfer

Here are the disadvantages of using a balance transfer offer to consolidate your debt.

The promotional rate is for a limited time. The main drawback of consolidating debt with a balance transfer is that the low or 0% rate is temporary. If you don’t pay off the entire debt before the rate expires, your balance will be subject to a higher standard interest rate. Therefore, paying off a balance transfer before the promotion expires is always best.

You pay transfer fees. Balance transfer cards typically charge a fee ranging from 3% to 5% of each amount transferred — plus, many have annual fees. For example, if you transfer $2,000 to a card with a 3% fee, you pay $60, increasing your debt to $2,060. However, you’ll come out ahead if you can save money on a balance transfer promotion despite the transfer fees.

You may have transfer restrictions. Transfer offers may restrict the types of debt you can move to the card. For instance, some issuers may only allow you to transfer card balances from other issuers. Or they may not allow transfers from an auto or student loan.

Consolidating debt to a lower-rate personal loan or a no-interest balance transfer card is a smart way to save interest, simplify your finances, and get out of debt faster. The right product depends on the type and amount of debt you have, how much you can afford to pay monthly, and your credit.

If you have a smaller amount of debt and can pay it off in a relatively short period, such as under two years, a balance transfer may save you the most. However, if you have a larger debt balance or multiple types of unsecured debts to consolidate, taking out a personal loan with a more extended repayment period gives you more flexibility.