Nobody plans to incur unmanageable credit card debt. However, most people always fall victim to this. People can become in debt for a variety of reasons, including medical bills, unanticipated emergencies, or job loss. Others may never have learned that it is preferable to pay off a credit card in full each month rather than carrying a large balance. If you have high-interest credit card debt and are ready to devise a repayment strategy for your loan, you may want to consider one of two popular options: Credit card refinancing or credit card consolidation. If you’re considering the first, then this article is for you. We’ll explain the credit card refinancing, and compare the refinancing vs debt consolidation.
What Is Credit Card Refinancing?
Credit card refinancing lowers your interest rates on a loan by either shifting debt from many credit cards to a single credit card with a reduced interest rate or combining your credit card debt into one monthly payment through debt consolidation.
There are five options:
- Transferring credit card balances
- Debt management for nonprofits
- Debt consolidation loan from a bank, credit union, or online lender
- A loan from a 401k plan
- Home equity loan
The best option for you is heavily influenced by your credit score. Those with weak credit, for example, will not qualify for balance transfer credit cards and may struggle to find an affordable debt consolidation loan. Nonprofit debt consolidation, on the other hand, is always an option because your credit score is not an issue.
Credit Card Debt Refinancing
There are several common methods for refinancing credit card debt:
- Apply for a new credit card with a lower interest rate.
- Be approved for a balance transfer credit card
- Apply for a personal loan to pay off the debt.
A balance transfer transfers debt from one or more credit cards to a new one with 0% APR for a set period of time. You make payments on the new card until your debt is paid off.
A personal loan, often known as a debt consolidation loan, entails applying to a lender for a loan large enough to pay off all of your credit card debt. The loan’s interest rate is substantially cheaper than the credit card’s.
Refinancing Credit Card Debt with Balance Transfer
Many credit cards offer 0% APR debt transfer rates to entice new, hopefully long-term consumers. There could also be a transfer fee of 1% to 5% of the total outstanding, which means you’re adding to your debt, so keep that in mind while making your selection.
The 0% introductory rate normally lasts 12-18 months. This means you only have a limited time to reap the benefits of interest-free debt. When the introductory period ends, you’ll be exposed to a normal APR ranging from 18% to -24%.
If you don’t pay off your balance, or at least make a dent in it, you’ll end up right back where you started.
If you acquire a 0% balance transfer card, don’t make any new purchases with it! Unless your card has a promotional rate of 0% APR on purchases, you will be charged interest on everything you spend.
So, if you use your new card to purchase a $500 dishwasher, you will be charged interest on that $500. If you truly need a new dishwasher, use a debit card, cash, or, if necessary, a separate credit card.
Even if your new credit card offers a low interest rate on purchases, you should be mindful about piling debt onto it. Remember, you received this card to get out of debt, not to add to it.
Credit Card Refinancing vs Debt Consolidation
Credit Card Debt Refinancing Using Debt Consolidation
Debt consolidation can reduce your APR while also allowing you to make a single, easy-to-manage monthly payment.
There are two options for consolidating debt and refinancing credit card debt. The first is nonprofit debt consolidation, while the second is a debt consolidation loan. The best option (as you may expect) is heavily influenced by your credit score.
A debt consolidation loan with negative credit makes no sense if the interest rate is competitive with or exceeds the rates on your credit cards. That is, if you are able to qualify for the loan in the first place.
The good news is that nonprofit debt consolidation is available to anyone.
Debt Consolidation Loan
A debt consolidation loan is an unsecured personal loan used to pay off debts. This technique works if you have a decent or great credit score, which is uncommon.
A debt consolidation loan only makes sense if the interest rate on the loan is lower than the interest rate on the credit cards you’re attempting to pay off. A decent credit score might get you interest rates as low as 11%. Even with a fair credit score, this alternative is worth considering if the rates provided are low enough.
The benefit of a debt consolidation loan is that the interest rate is fixed, so you won’t have to worry about fluctuating monthly payments. You’ll make the same amount every month until your debt is paid off, which normally takes 3-4 years.
Credit Card Refinancing vs Debt Consolidation
Credit card refinancing and debt consolidation are similar in that they both aim to pay off a loan while lowering the interest rate. When you refinance your credit card, you can negotiate with the credit card issuer to lower your interest rate so you can afford your payments. If they refuse to budge, you find a new credit card provider with a lower interest rate and pay off the remaining sum on the high-interest credit card.
Debt consolidation entails taking out a personal loan from a bank to pay off all of your credit card balances in full. This is done with the enticement that you will pay considerably less interest on the personal loan than you will on the debts owed to credit card issuers.
So, which is the best option? That is entirely up to you to decide. There’s a reason you have options when it comes to debt repayment. Your best bet is to choose the plan with the lowest interest and fees.
Debt Consolidation vs Balance Transfer
When picking between a balance transfer and debt consolidation, do your homework. Compare the fees and interest rates associated with a balance transfer or debt consolidation to the interest you are already paying.
It may be better to raise your credit score before pursuing one of these choices. Nonprofit credit counseling can assist you in developing the budget necessary to move you toward a good credit score.
Using a 401k Loan to Refinance Credit Cards
So you’re thinking of taking out a 401k loan to pay off credit card debt? This is a risky method that should be well explored.
One advantage of a 401k loan is that it has no effect on your credit score. Another advantage is that it offers lower interest rates than an unsecured personal loan.
However, 401k loans should only be used as a last resort. The penalties and fees connected with taking out and not being able to repay the money much outweigh any benefit associated with using a 401k loan to pay off credit card debt.
Taking money out of your 401k fund will lower your retirement and set you back financially several years as you approach retirement age. If you lose your work, the 401k loan balance is due within 60 days of termination.
Refinance Credit Cards With a Home Equity Loan
If you are in financial trouble and have equity in your home, a home equity loan may be advantageous for debt consolidation.
You must have equity in your property before considering a home equity loan. Equity is the difference between what you owe on a home and what it is worth in today’s market.
You can borrow against that difference and repay it at a fixed rate that should be cheaper than what you’d pay on a new credit card or unsecured personal loan. This loan is secured by your home, which serves as collateral.
If you fail to make payments, the lender may repossess your home. Another disadvantage of a home equity loan is that it lengthens the time it takes to pay off your mortgage.
Does Refinancing Credit Cards Harm Your Credit?
Possibly. It all depends on how you go about it. However, the majority of the harm that credit card refinancing can do to your credit score can be avoided or mitigated.
When you apply for a new loan or credit card, you consent to a rigorous credit inquiry. A hard inquiry decreases your credit score by a few points. No need to panic just yet; we all face difficult questions at some point. Catastrophe comes when you apply for several lines of credit in a short period of time. Applying for many debt transfer credit cards at once will damage your credit score before you’ve even been accepted.
Do your homework before applying, and just apply for one card.
Another thing to keep in mind is that acquiring a new credit card will lower your average account age, which accounts for 10% of your credit score. You can compensate for this by leaving your previous credit card accounts open, even after you have cleared their balances.
Finally, if at all possible, use a balance transfer card with a bigger capacity than you require. If you owe $2,000 on your credit cards, a balance transfer card with a $6,000 maximum might be excellent. This is because you want to keep your credit utilization rate (which accounts for 30% of your credit score) as low as possible. Use no more than 30% of your available credit.
The Benefits and Drawbacks of Consolidating Credit Card Debt with a Personal Loan
When you use a personal loan instead of a balance transfer card, you consolidate your debt and pay it off in predetermined installments. Borrowers make equal payments towards the debt at a fixed rate for a fixed period of time until it is totally eradicated. Borrowers also cannot add to their personal loan debt in the same manner they can to their revolving credit card debt.
Some Internet lenders and FinTech startups, such as SoFi, are upending traditional lending by providing transparent personal loans with no hidden fees.
A SoFi personal loan has no origination costs and no prepayment penalties. A prepayment penalty may discourage borrowers from paying off their loan quicker by imposing a fee to pay off the loan before the term expires or make extra payments.
If a borrower loses their job, they may be eligible for SoFi’s Unemployment Protection Program, under which debts may be eligible for interim deferment. During forbearance, no payments are due (though interest continues to accrue), allowing the borrower to get back on track before payments start.
Most personal loans allow the borrower to select a fixed interest rate. While a variable rate is normally offered at a lower rate of interest, it may climb as market rates rise, whereas a fixed rate ensures payments will not typically alter over time—provided the borrower always pays on time, of course.
The terms of a personal loan are almost usually determined by the applicant’s credit history and overall financial picture, which means that not every borrower will qualify, or qualify for a rate that is lower than the interest rate on their credit card (s).
Borrowers can receive a quote to be sure, but this choice may be preferable for people who have a stable financial history.
In Conclusion,
If you have high-interest credit card debt, refinancing is an excellent choice. The benefit of paying 11 percent interest on debt rather than 20% interest can add up to thousands of dollars in savings over time. It may take some time to sort through the possibilities and locate what best fits your financial circumstances, but you must start somewhere.
Consider visiting with a nonprofit credit counselor to see which solutions will work best for you in terms of reducing and eventually eliminating your credit card debt.
Frequently Asked Questions
How does refinancing credit card debt work?
The issuer of the new credit card pays off your previous balance, effectively shifting what you owe to the new credit card. Alternatively, you might use the money from the personal loan to pay off the old card. You pay monthly on the refinanced balance until it is paid off.
Can refinancing hurt your credit?
Refinancing will lower your credit score temporarily but may improve it in the long run.
