If you're stressed out about your debt and want to pay it off as quickly as possible, getting a lower interest rate is critical. For starters, you'll owe less on the overall debt, which has the potential to save you thousands in the long run. It also means that more of each monthly payment will go toward paying down the principal you owe instead of just trying to keep pace with interest charges. As you pay down the principal, your interest charges shrink, allowing you to get further ahead with every payment.
However, what's the best way to get that lower interest rate? Debt consolidation loans and balance transfers are the two primary ways to get the job done. Both of these options involve borrowing money at a lower interest from a new lender rate to pay off your existing debt, but there are differences between them.
A balance transfer is when you open a new credit card and use it to pay off your old credit cards. Typically, you have to get approval from the credit card company, and there's often a fee. A balance transfer is strictly for credit card debt.
Because a balance transfer still involves a credit card, it pays to be cautious when it comes to the fine print. Credit card companies have several ways of earning money off of your balance transfer:
Interest Rates: All credit cards have a monthly interest charge; the new interest rate must be significantly lower than your old one to make this transaction worthwhile. Sometimes the interest rate for balance transfers is different from the rate for new purchases, so be sure to read the terms carefully.
Promotional Rates: Many credit cards offer an incentive for balance transfers. Look for a 0% interest rate for balance transfers, which you can often find on cards that market themselves as "balance transfer cards." Be sure to check how long the promotional rate lasts, too. Your goal should be to pay the entire balance before the interest rate shoots up at the end of the period, which could be between six and 21 months.
Balance Transfer Fees: This is the price you pay to transfer your balance to the new card. It could be a flat rate or a percentage of the total amount you transfer. This is a one-time fee, so do the math to make sure that this amount isn't more than you would save in interest charges on your old card.
Annual Fees: Don't forget that some credit cards charge a fee each year just for owning the card. Avoid this if you can.
Balance transfers are strictly for credit cards, but debt consolidation can help you lump all of your debt into a single lower-interest payment. If you're also worried about a car loan, private student loans, or other types of debt, debt consolidation could be the solution for you. All debt consolidation involves taking out a new, lower-interest loan and using the proceeds to pay off your other debts.
There are two main types of debt consolidation products to choose from:
Debt Consolidation Loans: Whether you get this loan from a specialty lender or your local bank, they work the same way. The lowest interest rates come with secured loans, which use your house or car as collateral. You'll typically have three to five years to pay off this loan, which is set at a fixed rate so you can avoid surprises.
Home Equity Lines of Credit: A HELOC is the DIY version of debt consolidation. If you own a home and have paid your mortgage regularly, you probably owe less than the value of your house. A HELOC lets you borrow against that amount of money for a low interest rate, and you can use that cash to pay off your creditors. The advantage of a HELOC is that you have much more time to pay back what you borrow — often up to 30 years.
Getting Smart About Your Debt
If you only have credit card debt and are sure you can pay off your balance within the promotional period, a balance transfer could work well for you, provided you shop around for the lowest rates and fees. For most people, however, a debt consolidation loan or HELOC offers more flexibility to combine different types of debt and extra breathing room with an extended payoff period. In all cases, take the time to run the numbers on a loan calculator to make the decision that's right for you.