Capital Investment Advisors

Consolidation loan vs. balance transfer vs. DIY payment plan

Dear Opening Credits,

The age of my credit history is one year and two months. I have a credit card with a balance of $1,700 and an APR of 25.24 percent. Should I get a loan to pay off some of that? – Alexandra

Dear Alexandra,

You have several options; Let’s compare them.

You asked about a loan, and from what you describe I am guessing you are asking about a debt consolidation loan, so we’ll look at that first. I can’t say if you’ll qualify for one, because there are too many unknown factors. You have more than 12 months’ worth of credit history on your consumer credit reports, which is great, but a lender would also need to see your credit scores, total debt and income information.

If you’ve been using your credit card regularly, have been making all of your payments on time and owe much less than your credit line, your credit scores are probably good. Both FICO and VantageScore rank such actions favorably. Both credit scoring systems range from 300 to 850, and higher numbers (scores in the mid to upper 600s) should be sufficient for most consolidation loans. You can check your VantageScore here on for free.

Outside of credit scores, lenders likely will hone in on the total amount you owe and compare it to your income. If too much of your paycheck is already promised to other creditors, you will appear to be too great of a credit risk. Additionally, your income stream needs to be steady and stable.

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If you’re in a sound credit and financial position, a consolidation loan is in reach, and it may provide the strict parameters you need to pay off your high-interest card balance. But a consolidation loan may not be the best option.

Typically, a consolidation loan is a tool people use to lump several debts together, pay them off and have a set payment for a fixed period of time. Many lenders (including online lenders, such as Upstart or Prosper, among others) offer favorable interest rates, which can reduce the amount of money you spend on finance fees.

You also can come out ahead because consolidation loans don’t allow you to send tiny minimum payments, as with your credit cards (typical minimum payments are 1 percent of the balance, plus interest). With a consolidation loan, you convert credit card debt from revolving debt to fixed debt.

What does that mean?

  • Revolving debt requires only a small minimum payment each month. You also get to choose how much to repay, and how long you will take to pay off the debt. That freedom comes at a price, as stretching out payments costs you more in interest.
  • Fixed debt is, as its name implies, more rigid. You have a set monthly payment and a firm payoff date. Given the relatively small size of your debt, it likely would be one to three years.

Another option could be a balance transfer card with a 0 percent interest promotional period. Many of these cards offer up to 12 months or more of no interest. You could transfer your balance to the card, and pay off what you owe (divide your balance by the number of months within the promotional period) with no interest. If you’re unable to pay off the balance within that promotional period, though, any balance left would be assessed at the card’s standard higher APR.

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Here is a side-by-side repayment comparison for the $1,700 debt you have:

Credit card minimum payment plan: Let’s assume your credit card issuer has the typical minimum payment of 1 percent of balance, plus interest. At that rate, paying just the minimum, it would take you 10 years and nine months to repay your debt, and cost you $2,436 in interest charges. Not so good.

Consolidation loan payment plan: Now assume you were able to get a three-year loan with a 14 percent interest rate. Most lenders charge an origination fee, which can be up to 6 percent of the balance. For the sake of discussion, I’ll assume a 5 percent fee, which is added to the debt – $85. For this plan, the monthly payment would be $59, and the total interest charges would be roughly $349 over the 36-month repayment period.

Balance transfer card: If you are approved for a 12-month 0 percent balance transfer card, you would have to pay about $142 a month for 12 months, with no interest charges, to erase your $1,700 debt. If approved for a 15-month 0 percent balance transfer card, your monthly payments would be about $114, interest-free.

Big differences, right? Yes, but you may not need to go to such lengths.

An alternative plan would be for you to ignore the request for minimum monthly payments and commit to sending far more on your existing card. Under a do-it-yourself debt payoff plan, if you were to send a flat $150 every billing period, you would be debt-free in 14 months, and it would cost you just $262 in interest. You wouldn’t have to go through the hassle of applying (and possibly being rejected) for another credit card or loan, either. After a few months of on-time and substantial payments, you might even be able to persuade your credit issuer to drop the interest rate, which would save you even more money.

Use our balance transfer calculator and our debt payoff calculator to play with the numbers, and see which choice is right for you and your budget.

Once you pick a plan, stick with it, and you soon will be free of your debt. One caution: Once card balances are paid off, the temptation to spend with them again may be great. Try to use this debt repayment period as a learning opportunity, and do not let it happen to you again.

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