Credit Card Refinancing vs. consolidation: which is better? Both can be good options for dealing with your financial situation. Which is better depends on how much debt you have, how good your credit is, and how fast you can pay it off.
- Consolidation requires getting a low-interest loan to pay off high-interest credit card balances.
- Refinancing requires getting a 0% introductory rate card in order to move balances over from higher-rate cards.
While these tools may lower interest rates, they don’t address the underlying problem. You must pay off existing balances and develop a plan to make sure you don’t get in debt again. Otherwise, these tools only prolong your problems.
How Does Refinancing Work?
Refinancing works by you getting a new card with a 0% introductory interest rate. Then, you move your balances from your old cards to the new one and pay off the total liability within the introductory period. This approach works best when your
- Credit scores are high enough to get a 0% rate introductory card
- Balances on high rate cards are low enough that you can pay them off in the 12-18-month period
- Income is sufficient to make payments above the minimum amounts
This must be a quick fix for your problem, because if you don’t get the balances paid off during the 12-18-month window then you have a high-interest rate on your debt again. You will be in a similar situation as when you started.1
Advantages and Disadvantages of Refinancing
You should use this approach if you believe you can pay off the balances in a short period of time. Before you do this, you should think about:
- It can save you a lot on interest payments for a short time. That gives you an opportunity to pay down the principal quickly.
- You must have high credit scores to get accepted.
- Don’t be tempted to spend more on the card just because the credit is available
The two biggest issues with this approach are getting approved for the card and your ability to pay down balances quickly. If you don’t have high scores and the ability and discipline to pay down the principal quickly then don’t try this.
Is It Smart to Refinance?
It is smart to get rid of your balances as quickly as you can. You can certainly do that with this approach if you have good credit and discipline. It’s not for everyone, though. Here are some questions to consider before you apply for that new card:
- Is your score above 680?
- What is the transfer fee for the card you chose (they usually charge 3%-5%)?
- What are the exact balances for the accounts I want to pay down?
- How high is the credit limit for the card you chose?
- How much can you put toward paying down the balance each month?
If you make a worksheet and figure out the amount you will pay down is significant this may be a good approach for you. On the other hand, if it’s an insignificant amount you may want to look at another alternative, like a consolidation loan or a snowball.
How Does Consolidation Work?
Consolidation works by transferring credit card balances into other lower-interest rate loans. There are a few loan options available. Which is best depends on your individual situation.
- Mortgage refinance
- Equity loan
- Personal loan
The first two are secured loans that use your house as collateral. In order to use these, you must own a house with equity available. Refinances offer the lowest interest rates. However, they take time and have substantial closing costs. Also, you can lose your home if you don’t pay your bills. Only do this if you have large high-interest balances. Equity loans also use your home as collateral. They are second mortgages and have higher interest rates because they are riskier for the bank, but they are still much lower than revolving interest.
Finally, if you don’t own a house or have equity in your home you can still get a personal loan. This is unsecured, so it has the highest interest rate of the three options. It has an origination fee (up to 8% of the amount borrowed). The interest rate depends on your scores, income, and debt load.
Advantages and Disadvantages of Consolidating
You should use this approach for substantial debt that you need more time to pay off. Things to consider with this approach are:
- Interest rates are much lower and fixed
- These loans have set repayment periods from 5 years for personal loans to 30 years for mortgages
- They have large closing costs and origination fees, sometimes into the thousands of dollars
- They take time, anywhere from 15-60 days to process
- For mortgages and equity loans you put your home at risk of foreclosure
If you have a lot of credit card debt you may want to consider this. But before you do, think about how you accumulated the debt in the first place and develop a financial plan where your spending is less than your income.
Is It Smart to Consolidate?
It is smart to consolidate high-interest revolving credit into low fixed-rate loans if you can keep spending less than income. This strategy is good for high balances, and you have to really think about how your liabilities got that high to begin with. Further, you must take steps to make sure it won’t happen again.
Credit Card Refinancing Vs. Consolidation: Which is Better?
Neither refinancing nor consolidating fixes the underlying problem. Interest rates, terms, and loan structures address symptoms. The real issue is the debt itself. Some people find themselves in debt because of a job loss, illness or other emergencies that they couldn’t see coming. Others find themselves in debt because they can’t control their spending.
Credit card refinancing vs. consolidation isn’t really the first question you should consider. Either way, the hard reality is that we must budget our resources. Limit discretionary spending and save for emergencies. Having a budget doesn’t mean that you won’t incur debt. It does mean that you might be able to avoid it in some cases and limit it in others. Neither of these options gets you out of debt because:
- They both only change the terms, not the balance
- Consolidation extends the repayment period for the same debt
- Neither can guarantee a lower interest rate
- Neither eliminates any debt
If you don’t lower the balance you will find yourself in the same situation, or more likely, a worse situation. Focus on paying down your balance rather than lowering your interest rates. That is how you will get out of debt fastest.2
We mentioned the snowball earlier, and we believe it is the best tool to get out of debt fastest. Consider it while you are thinking about shuffling around your balances. It’s better to eliminate it than to rearrange it.