Debt Consolidation vs. Credit Card Refinance: What Are The Differences?

Posted on December 11, 2020 in Credit Cards

The usage of credit cards have only increased every year as purchases made with them are way more common and much more expensive than their cash counterparts. Trying to balance credit card debt can be quite challenging considering most credit cards come with interest rates and minimum monthly payments. Learn what the differences are, including the pros and cons to debt consolidation vs credit card refinancing.

There are quite a few options available for anyone trying to better negotiate and control their debts, and two of the most common ways are credit card refinancing and debt consolidation. While these two options are similar, and with the same end goal in mind, there are also several key differences between them. 

Credit Card Refinancing

Credit card refinancing is basically when you transfer the balance of one credit card to another, literally opening up a new credit card account in order to pay off an existing credit card. 

Now this may sound redundant, but if done correctly it can be a very effective strategy when trying to eliminate debt. The plan all hinges on being able to get a new credit card with a lower interest rate than the one being paid off, so this option is best suited to those with better credit scores. 

Most credit cards offer promotional periods with 0% interest rates, so if a borrower is able to pay off the entirety of the debt during that period, they could save a substantial amount of money on interest. 

Let’s say a person has a credit card debt of around $5000 with a 15% interest rate. The longer it takes to pay it off, the more money over the original $5000 the borrower will pay due to interest. By opening up the new credit card (often a balance transfer credit card), the interest rate will be lower or nonexistent, so the debt wouldn’t be increasing at all or if it is not nearly as quickly as the 15% rate. 

Ideally the goal would be to pay off the entirety of the debt while the new card is still under the promotional rate because credit card interest rates tend to skyrocket after the promotional period ends, and may even end up higher than the interest rate trying to be avoided. 

So, this option doesn’t come without potential downsides but if paid off fast enough, this strategy can save a borrower a lot of money from high interest rates. 

Debt Consolidation

This process is similar to refinancing but typically is used for multiple credit card balances as opposed to just one. 

Say that you have 3 credit cards with balances of $500, $2000 and $5000 with interest rates of 10%, 12% and 15%. Instead of slowly paying off each one, and having the interest rates tacking on extra money, debt consolidation would roll all three into one balance. 

Typically new credit cards open up with promotional periods of low to no interest, so a credit card with a debt of $7500 and an interest rate of 0% if only for 12-18 months would go a long way to helping save money in interest payments. 

Ultimately the card would have to be a lower interest rate than the others for this method to be its maximum level of effectiveness, but with only one monthly payment due instead of three, it would also help save some money in the short term as well. 

Personal Loans Instead of Credit Card

In the previous examples the solution was to open a new credit card to begin the process. However that’s not always the best solution depending on credit ratings and credit limits. With a poor credit rating the interest rate may actually be higher on the new credit card, defeating the entire purpose. Additionally, with a low credit limit, it may not even be possible to add all the total debt to the new card, again making it pointless. 

However, there are still ways to refinance and consolidate credit card debt. Personal loans can be used in order to pay off debt in fixed installments at a fixed rate for fixed time until it’s eventually paid off in full.

One of the reasons this method is preferred over opening up another credit card is that a personal loan is defined and finished. Any time a credit card is used, more debt is created while the personal loan very simply is exactly what it is, interest rates not included of course. 

Debt Consolidation vs Credit Card Refinance: Alternative Routes to Eliminating Debt

It’s a good idea for anyone deep enough in debt to speak with a financial advisor.  However there are alternatives that could potentially help eliminate debt without opening a new credit card or taking out a loan. 

Credit card refinancing and consolidation work best the higher a credit score is, so anyone with a poor credit score can utilize these options as well before attempting to secure more lines of credit or loans.  

Correcting Poor Spending Habits: While refinancing and consolidation can go a long way to help get someone out of debt, it will be pointless without first knowing how the debt got out of control in the first place. Accruing lots of credit card debt means simply that a person is spending more money than they are making and therefore operating at a loss. No amount of refinancing or consolidation will repair that. Even if they do it would only be a temporary solution to a permanent problem and most likely would result in overwhelming debt later on down the road. 

Making For Better Budgeting: Making a budget can come in handy and could potentially help to avoid refinancing or consolidation altogether. Since credit cards can be used for just about any item or service imaginable they can quickly run up a debt. By budgeting for spending less money and putting more towards paying a debt, it would be paid off much faster without having to take out new credit cards or loans. 

Negotiating with Creditors: Unlike an auto loan or mortgage where failing to make payments can result in the car or home being forfeited, credit card debt is considered unsecured debt. This is important because in times of economic catastrophe the first bill people stop paying is often the credit card bill. Failing to pay the electric bill means the electricity could be turned off but outside of potential hits to one’s credit there isn’t much taken away when failing to pay a credit card. This is important because it opens up the possibility of negotiating the terms of a credit card payment plan. Credit card companies will gladly take all the debt repayment but will prefer some of it over none of it. Simply calling them and asking for a lower monthly payment or reduced interest rate can easily be attained and help get a borrower out of debt quicker.   

Potential Risks of Debt Consolidation vs Credit Card Refinance

As is the case with just about anything in life there are potential risks and consequences to credit card refinancing and consolidation. In the world of economics and finances nothing is ever a 100% fool proof plan. 

Here are a few examples of potential dangers or pitfalls of refinancing and consolidating to keep in mind: 

  • Damaged credit score: Applying for an official debt consolidation loan may drop a credit score due to the hard inquiry along with any hits the credit score is already taking from the outstanding debts. Additionally, if you pay off debt using either method and then just re-accrue more debt, your score will get brought down for sure. 
  • Nothing is guaranteed: Lots of factors go into the rates and limits sets on credit cards and loans. Depending on credit score, income and other various factors of the borrower, a new credit card or consolidation loan may not have lower interest rates on the existing debts or may not be high enough in order to pay off the debts altogether.
  • Fees: Depending on the type of debt consolidation loan, a fee may be added on top of the interest rates, and some companies will charge a fee of a few percent when transferring the balance of one credit card to another.
  • Losing collateral: Taking out a secured loan means putting up it’s value in a collateral item such as a house or vehicle. Failure to pay back the loan could result in the forfeiture of said items, so be careful what type of method you use to try and consolidate your debt. 

Debt Consolidation vs Credit Card Refinance: The Takeaway

Both strategies can help save you money on interest, but credit card refinancing is really just for one debt, while debt consolidation is more so for multiple debts.

At the end of the day, anyone interested in credit card refinancing or debt consolidation has many options and services available to them. 

If they are just trying to adjust a single credit card debt then refinancing would be the ideal option, and if the goal is to bundle several payments into one and save on interest then consolidation would be the best course. 

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