Does debt consolidation ruin your credit?

A debt consolidation loan can help improve your credit score in the long run, provided you stick to its payment plan and do not build more debt. You may expect your credit score to drop by a few points when you apply for a debt consolidation loan. However, moving your revolving credit from credit cards to a debt consolidation loan helps bring down your credit utilization ratio, which, in turn, helps improve your credit score. Making timely payments toward your debt consolidation loan might lead to an improved payment history, which, too, affects your credit score in a positive manner. Further, getting a debt consolidation loan can add to your credit mix, which is also good for your credit score.

What is a balance transfer in debt consolidation?

If you're using a debt consolidation loan to transfer balances from existing credit cards, you're essentially using proceeds from the loan to pay off your existing credit card debt. On the other hand, debt consolidation through balance transfers involves using a balance transfer credit card to pay off outstanding balances from two or more existing credit cards. However, the combined total of the balances you wish to consolidate/transfer cannot exceed the new card's balance transfer limit.

When should you not consolidate debt?

Consolidating your debt might not make much sense if you don’t qualify for a lower interest rate. You might want to steer clear of debt consolidation if you feel you might benefit more through a credit card’s 0% APR offer on balance transfers. You may also want to reconsider consolidating your debt if you think you may not be able to afford to make the required monthly payments.

Balance Transfer Credit Card vs. Debt Consolidation Loan: Which Is Better?

Debt consolidation loans and balance transfers can help you manage your debt and lead to lower interest charges.

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Whether you should get a debt consolidation loan or a balance transfer depends on the amount of debt you wish to repay and how long it will take to pay it off. While balance transfers are more suited when paying off small balances, debt consolidation loans tend to work better when combining debts of larger sums.

A balance transfer credit card lets you benefit through a 0% APR offer that stays in place for 12 to 21 months. At the end of this period, any outstanding amount starts accruing interest. A debt consolidation loan, on the other hand, typically comes with lower interest rates than credit cards, but the interest starts accruing immediately. You need to make fixed monthly payments for a predetermined time period that usually ranges from one to six years.

>> MORE: THE BEST BALANCE TRANSFER CREDIT CARDS

The debt consolidation loan vs. balance transfer comparison does not produce a clear winner because the one that might work better for you depends on your specific situation.

MoneyGeek’s Takeaways

Balance transfer credit cards come with 0% APR offers that stay in place for 12 to 21 months.

Debt consolidation loans usually have lower APRs than the regular APRs of balance transfer cards.

Balance transfers work well for smaller amounts, whereas debt consolidation loans are better suited for larger amounts.

Is a Balance Transfer the Same as Debt Consolidation?

Even though both might be of help in repaying existing debt, a balance transfer is not the same as debt consolidation. With a balance transfer, you move existing debt from one or more credit cards to a different card with a lower APR. Typically, this involves using a new card with a time-based 0% APR offer on balance transfers.

As long as you pay off your transferred balance within the promotional period, you do not incur any interest charges. However, any remaining balance at the end of the promo period starts accruing interest at the card’s regular balance transfer APR. Some balance transfer credit cards offer balance transfer checks that you can use to repay other forms of debt. The amount you may transfer to a credit card is typically any amount less than the available credit limit, but this can depend on the bank.

The debt consolidation vs. balance transfer comparison tilts in favor of the former when it comes to how much debt you may combine. This is because debt consolidation loans tend to come with higher approval limits than balance transfer credit cards. Besides, you may use a debt consolidation loan to combine different types of debts such as credit cards, personal loans, auto loans and student loans.

A debt consolidation loan requires that you make fixed monthly payments for the life of the loan. These loans tend to be unsecured, meaning that they are not backed by any collateral (your car, your home, etc.). People with poor credit histories may want to consider applying for a secured debt consolidation loan instead because secured loans have a higher chance of approval. Whether you obtain a secured or unsecured loan, you can typically choose a term of one to six years, depending on your financial situation. These loans come with fixed APRs that are often lower than credit card APRs.

>> MORE: BEST CREDIT CARDS FOR BAD CREDIT

Balance Transfers and Debt Consolidation at a Glance

Balance Transfer Credit Card
Debt Consolidation Loan
How to Request
Online, over the phone, in person
Online, over the phone, in person
When to Use
To repay high-interest credit card debt
To repay large amounts of debt from
different sources
Repayment Terms
Need to make at least minimum monthly
payments; regular APR applies at the
end of the promo period
Fixed payments through the course of
the loan term; APR remains the same
throughout
Credit/Loan Amount Limits
Typically any amount less than a card's
available credit limit
Secured: Up to $500,000
Unsecured: Up to $100,000
APR Ranges
0% APR offer usually applies for 12 to 21
months; then, the card's regular APR
takes effect
3.22% to 35.99%
Other Fees
Balance transfer fee: 3% to 5% of the
amount you transfer
Loan origination fee: Up to 6% of the borrowed amount
Prepayment penalty: Up to 5% of the borrowed amount

Pros and Cons of Balance Transfer vs. Debt Consolidation

While a debt consolidation loan or a balance transfer might help you deal with existing debt, one may work better for you than the other, depending on your circumstances. This is because both come with their share of pros and cons.

Pros and Cons of a Balance Transfer

Pros

Based on the duration of the 0% APR offer, you pay no interest for 12 to 21 months.
Getting a new card might help improve your credit utilization ratio, and thereby, your credit score.
Balance transfer cards may come with other benefits, such as no annual fees, no foreign transaction fees and spend-based rewards.

Cons

The APR that applies after the promo period might be high.
You typically need good to excellent creditworthiness to qualify.
Balance transfer fees with 0% APR offers range from 3% to 5%.
Canceling your old card can hurt your credit utilization ratio and credit score.
You can't be sure of the credit limit you qualify for until your card’s approval.

>> MORE: WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF A BALANCE TRANSFER?

Pros and Cons of a Debt Consolidation Loan

Pros

It can help consolidate large debts.
A single monthly payment can help simplify managing your debt.
You might qualify for a low APR if you have good to excellent credit.
You might be able to repay your debt sooner.
It can bring down your credit utilization ratio and improve your credit score.

Cons

No 0% APR offers.
Interest begins accumulating immediately.
Loan origination fees can be as high as 6% of the borrowed amount.
A prepayment penalty might apply.
An average credit score might bring with it a high interest rate.

>> MORE: WHICH IS THE BETTER OPTION FOR DEBT REPAYMENT - BALANCE TRANSFER CREDIT CARD VS. PERSONAL LOAN?

Should You Get a Debt Consolidation Loan or a Balance

If your existing debt comes with medium to high interest rates, getting a debt consolidation loan or a balance transfer credit card can result in reduced interest charges, a lower overall monthly payment and fewer bills to track. However, determining which might work better involves paying attention to different aspects.

What is your existing debt? A balance transfer card might work well for you if the total amount you wish to transfer from existing cards falls within the new card’s credit limit. If you don’t get approved for a high enough credit limit to transfer all your high-interest debt, you’ll end up with a balance remaining on your old card and a new maxed-out card. In such a scenario, a debt consolidation loan might be the better alternative.
How much time do you need? Getting a balance transfer credit card might be worth it if you think you might be able to repay the entire debt you wish to transfer during its 0% APR offer period. If you need more time to repay your debt, a debt consolidation loan might work better for you. While 0% APR balance transfer offers usually last for up to 21 months, debt consolidation loans can come with loan terms of up to six years.

MONEYGEEK QUICK TIP

Some consumers transfer balances repeatedly to take advantage of multiple 0% intro APR offers, rather than a debt consolidation loan, as they pay down their debt. While this strategy can work for some, it is risky because there's no guarantee that you'll be approved for the next 0% intro APR offer. If you fail to qualify, you'll be stuck with a balance on another high-interest rate card. — Lee Huffman, credit card expert at BaldThoughts.com

>> MORE: HOW MUCH MONEY COULD A BALANCE TRANSFER SAVE YOU?

Balance Transfers and Debt Consolidation Loans Alternatives

If you fail to qualify for a debt consolidation loan or a balance transfer credit card, you may still work on clearing your debt in other ways. The severity of your debt and your ability to make repayments will affect which method might work well for you.

Contacting creditors
If you’re having trouble keeping up with your monthly payments, consider contacting your creditors directly. Depending on your situation, you might qualify for hardship programs or get to make lower payments.
Budgeting
People tend to get into debt because of careless spending habits. If you find yourself in this boat, the first step you need to take is to create and stick to a weekly/monthly budget that helps you spend less.
Debt management plan
Credit counselors help people who have trouble managing unsecured debt by getting them on debt management plans. Debt management plans usually give you up to five years to clear your debt. Unlike debt consolidation loans, a debt management plan does not involve taking on more credit. It usually requires that you send a single payment to your credit counseling agency, which, in turn, disburses it to your creditors.
Start a side hustle
Earning additional money outside of your day job can help you pay down your debts. There are many ways to make extra money, like driving for Uber, delivering for DoorDash, selling crafts on Etsy, tutoring students and more. Focus on the skills you have and market them to people who need your help.
Debt settlement
If you’ve missed making a few payments toward your credit cards, their issuers might be open to accepting less than what you actually owe through debt settlement. However, taking this path will likely hurt your credit score, and mention of it stays on your credit report for seven years. Additionally, the amount forgiven by the creditor may be considered taxable income that you need to report on your taxes.
Home equity
Some homeowners might think about borrowing against the equity of their homes. However, not making timely payments can result in you losing your home. If you are certain you’ll be able to keep up with the repayments, your options for digging into your home’s equity include home equity lines of credit (HELOC), home equity loans and cash-out refinancing.
Bankruptcy
You may consider taking this step only if none of the other avenues work and after seeking professional assistance. While bankruptcy might help wipe out your existing unsecured debt, know that it has a significant adverse effect on your creditworthiness and your ability to get credit in the near future.