Balance Transfer vs. Debt Consolidation

Being saddled with debt can impact many areas of your life. It can hurt your credit score, which makes it harder to secure a car or home loan. Then there’s the persistent dread every time bills arrive or the phone rings with an unknown number. It’s no wonder more and more people are researching tactics to get out of debt faster. One common question debtors ask is, “What’s the difference between a balance transfer and debt consolidation?”

In simple terms, balance transfers are one form of debt consolidation. For example, at Discover you can apply for a balance transfer offer up to your available credit line to transfer high-interest debt from credit cards, loans, and more to save with a low promotional APR (if you’re approved). This may mean you transfer credit card debt from one or many cards to your Discover card with a promotional interest rate. However, you could also apply for a personal loan or home loan to consolidate your debt.

What is a balance transfer?

A balance transfer is when you take the balance of the amount you owe from one loan (for example credit cards, loans, medical bills) and move it to another credit card account; this is often done to pay off debt at a lower interest rate. For example, if you carry a balance on a high-interest credit card and transfer it to a card with a lower interest rate, maybe even one with a 0% balance transfer introductory rate, you could pay down the balance more quickly because you’re paying less in interest charges.

However, understand that the APR will rise after the introductory period, so make sure you’re aware of what the standard APR will be. There may also be a balance transfer fee, so make sure to read the terms and conditions of each offer.

It’s important to do your homework when considering a balance transfer offer. Add up the total amount of debt you’re carrying, calculate how much you can pay toward the total debt during the low promo APR window and then how much you will pay in interest after the rate reverts to a higher APR. Compare what you would pay at your current APR to the balance transfer opportunity. Don’t forget to add in any fees associated with the balance transfer before making a decision.

If you do decide to move ahead with a balance transfer, remember the low promotional APR only applies to the transferred debt. In many cases, if you make new purchases, say on the credit card you made the transfer to, card you will be charged the standard APR, which can be much higher.

What is debt consolidation?

Debt consolidation loans move high-interest debts (including credit card balances) into a single, often lower-interest, payment.  Consolidation may be a way to simplify or lower payments. However, it is important to remember that it does not erase your debt.  

There are two main types of debt consolidation loan programs: secured and unsecured. A secured loan has an asset backing it, such as a home, vehicle or even a retirement fund. An unsecured loan is not tied to collateral, and since it’s more of a risk to the lender, it typically has a higher interest rate than a secured loan. There may be an exception if the borrower has a very high credit score.

A common type of secured debt consolidation is a home equity loan. If there is a significant difference between your current home value and the mortgage balance, you may be able to borrow against that equity to receive a lower rate than with an unsecured loan.

It can be crucial to research every debt consolidation lender you consider using, as fraud is a possible risk. A reputable organization will send you everything you need to know about their services without you having to provide any detailed financial information. They will also be licensed to offer services in your state with accredited and certified counselors. Research credit counseling agencies with your state attorney general and local consumer protection agency before signing on the dotted line.

Which is better for my credit score: Balance transfer or debt consolidation?

One option isn’t inherently better than the other for your credit score; it all depends on your own credit history. For example, you may want to take your revolving credit utilization ratio, which is your total revolving debt compared to your total revolving limits, into consideration as this is an important component in the amounts owed category which makes up about 30% of a FICO® Credit Score.¹ Adding another line of credit with a high limit may reduce your overall ratio and with a lower interest rate, you can pay more toward the principal every month, lowering your debt in the long-term.

One thing to watch out for with balance transfers is unintentionally increasing your credit utilization ratio by canceling cards once the debt is transferred. For example, if the limit on the new balance transfer credit card you open is $10,000 and you cancel your old credit card after transferring $9,500 worth of debt, your credit utilization rate will jump to 95%. This will likely have a negative impact on your credit score. It may be advantageous to keep those old cards open, even if they’re not being used often given that length of credit history typically contributes about 15% of your FICO® Credit Score.¹

Whatever you decide, it’s important to review your options, and chose what works best for your situation. Good luck!