The most common form of personal debt is credit card debt. The average American family carries a balance of $8,000 on several credit cards; this quick and easy form of borrowing comes at a price. Credit card interest rates can go as high as 40%.
You have a number of options in dealing with credit card debt. Two of the most common ones are transferring all of your balances onto a single credit card, or consolidating your debt with a loan. Each of these options has a number of pros and cons.
Balance transfers - the pros
You can save a lot of money simply by transferring the balances from several high-interest credit cards onto a single low-interest (or even interest-free) credit card. You can use the savings to pay down the debt by making more than the minimum monthly payments. As a result, you can be debt-free much sooner.
Balance transfers save you money in other ways, too. It’s easier to keep track of a single monthly credit card bill, than many smaller ones. You are less likely to forget to make a payment, thereby avoiding costly late fees. Missed payments also reflect negatively on your credit score. A lower credit score means higher interest rates.
Video: Credit Card Balance Transfers
Balance transfers - the cons
Once you’ve transferred your debt onto a single card, you must pay it off quickly. The low interest rates do not last forever. At the end of the introductory period, the rate will increase dramatically. You then have the option of shifting the debt onto yet another credit card. Doing this continuously will damage your credit history.
In some cases, you may have to pay a fee of around 3% on the balance transfer. Doing this once may be financially prudent. After the second or third time, the fees add up. And if you miss even a single payment, the introductory interest rate can go up immediately, leaving you with a high balance and a high APR.
Credit card consolidation – the pros
With debt consolidation, you take out a low-interest loan and use that money to pay off all of your high-interest credit cards. You are then left with a single monthly loan payment, which can be significantly lower than what you were paying to the credit card companies. The main benefit of this is the money you save on interest payments. It can really add up over several years.
Another benefit is that it simplifies your finances. It’s not hard to keep track of a single loan. And if you can keep up with the payments, it can actually help you rebuild your credit history.
Debt consolidation only makes sense if the APR on your debt consolidation loan is lower than on your credit cards. Depending on your credit score, it may not be.
The price you pay for lower monthly payments is that it takes longer to pay off the debt. Before you sign on the dotted line, make sure you know how long it will take to pay off the balance and how much interest you will be paying in the meantime. If you’re not careful, you can actually end up in more debt than when you started.