Balance Transfer Vs Debt Consolidation: Which Is Better?
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Debt is the one harsh reality of life that we cannot escape from. The biggest problem that comes with debt is that most people usually have many debts that they need to pay off at the same time. Taking the interest payments into consideration, some debt payments can get ridiculously expensive over time.
Fortunately, this is a well recognised problem. Financial institutions tend to offer a few ways for individuals with multiple debts to reduce their interest payments and limit financial strain. Among these solutions are balance transfers and debt consolidation.
In essence, these are two different methods that result in the same outcome, a reduction in overall interest payments. But which one is the better option for you? Let’s have a look.
How balance transfers work
A balance transfer works by moving your debt account balance from one credit card provider to another. For example, you might transfer debt from a high-interest credit card to a credit card with lower interest rate, preferably a credit card with a 0% balance transfer promotion.
With this method, it is possible to reduce the interest rate on your debt. Lower interest rates means less payments overall, and even the possibility of paying off the debt faster.
In many cases, a balance transfer involves moving a debt to a credit card offering a promotional interest rate. You might be able to take a higher-rate installment loan balance or the balance from another credit card and move it to the credit card, lowering the interest rate that you are paying.
Here is an example of how a balance transfer works. Let us assume the following:
Current debt: RM10,000
Interest rate: 10%
Monthly payments: RM300
With this, you would be paying approximately RM1,764 in interest, and RM11,764 in total. If you pay RM300 per month, you will only be able to pay off your debt in around 40 months.
Now let us assume you get a new balance transfer credit card with the following features:
Interest rate: 3%
Promotional interest rate: 0%
Promotion length: 12 months
Balance transfer fee: 3%
With the above parameters, your new balance transfer credit card will offer you 0% interest for the first 12 months. As such, you will only need to pay RM300 for the initial balance transfer fee, and RM203 in interest. In total, you will only be paying about RM10,503. Assuming that you still intend to pay RM300 per month, you will pay off your debt in around 36 months. With the balance transfer credit card, you would be saving about RM1,261.
In general, you need to meet certain criteria to qualify for the balance transfer offer from the credit card. Depending on the situation, you might need a good to excellent credit score in order to be approved for the balance transfer offer.
Pros and cons of balance transfers
| Pros | Cons |
|---|---|
| Potentially reduce the interest rate on the debt | Low interest rates are generally available for a limited time before the rate rises |
| Pay off the debt faster, since more of the payment goes toward reducing the principal | The available credit limit might not be high enough to transfer the entire balance of your debt |
| Credit card balance transfer fees can be as high as 5% |
How debt consolidation works
Debt consolidation is the act of using a personal loan or dedicated debt consolidation loan to put all your debts in one place, potentially at a lower interest rate, whilst making your debts easier to manage. It can also result in lower monthly payments as well.
While you can use personal loans for debt consolidation, you can also use the funds from personal loans for just about anything else as well. It is possible to use the funds to make a large purchase or cover emergency expenses. The funds from a personal loan are, for the most part, more flexible than a balance transfer.
Here is an example of how debt consolidation works. Let’s assume the following:
| Remaining debt (RM) | Monthly payment (RM) | Interest rate (APR) | |
|---|---|---|---|
| Credit card 1 | 10,000 | 300 | 10% |
| Credit card 2 | 15,000 | 250 | 8% |
| High-interest loan | 7,500 | 200 | 19% |
Based on this, your average APR would be around 11.02% for all three debts and your total monthly payments would be RM750. You would be paying this amount for 56 months, with total payments amounting to around RM41,630. Of this amount, approximately RM9,130 would be interest.
Now let’s say that you took out a personal loan for debt consolidation with the following parameters:
Loan amount: RM35,000
Interest rate (APR): 4%
Loan term: 5 years
Additional fees: 0.5%
With this, the interest rate of your consolidated loan with fees would be around 4.21%, which is much lower than your three individual debts. This means, you will be saving money with the consolidation loan. After a loan fee of RM175, you can get RM34,825 to be used to pay off your remaining debt balance of RM32,500. This will leave you with an additional RM2,325 after consolidation which you are free to keep or spend as you see fit.
With debt consolidation, you would only need to pay around RM644.58 per month for 60 months. This would result in a total payment of around RM38,675, of which RM3,675 would be interest.
However, one big caveat about personal loans is that it is heavily reliant on your credit score in order to get lower interest rates. The better your credit score and credit history, the easier it is to negotiate lower rates.
Pros and cons of personal loans
| Pros | Cons |
|---|---|
| Many loans to choose from | Additional fees might be charged |
| Can borrow money for debt consolidation and other purchases if needed | There is a set payment plan that you have to stick to |
| Some lenders provide funds very quickly |
Which is the better option
Between balance transfers and personal loans for debt consolidation, the better choice depends entirely on your financial situation. Generally speaking, if you have a relatively small amount of high-interest debt, balance transfers that offer a 0% interest promotional rate are highly beneficial. The lower interest rate helps you to pay off your debt faster, as long as you can do so within the promotional period.
If you need to borrow a large sum of money, then a personal loan might be best. Personal loans can help you to consolidate large debts and pay them off over an extended period of time. Additionally, as a new loan, it is possible to use the funds for other purposes.
Why not both?
Nobody said you have to choose one or the other. You can use both methods simultaneously under the right conditions. You can utilise a balance transfer to transfer for a portion of your high-interest debt while also using a personal loan to consolidate the rest of the debt.
Additionally, you might use a balance transfer to reduce your interest rate on your debt while using a personal loan to tackle other purchases. Simply consider your financial situation and determine what is likely to make the most sense for you in the long-run.
