Consolidation loan, not BT, may be your best bet

This post originally appeared May 11, 2017 on CreditCards.com as “‘Loan can boost score faster than balance transfer deal.”

By Barry Paperno

Dear Speaking of Credit,
I was offered a balance transfer and a $3,000 raise on my credit line on a card I already have, no hard inquiry. I transferred $1,900 (39 percent use); $600 (38 percent); $1,050 (59 percent); and $400 (5 percent) from different cards to the card that had 66 percent use before limit increase. Now I have seven credit cards at or below 5 percent and the one probably at or near 100 percent with a lower APR than the transfers.

I  also have other things on my credit: a loan with set repayment one-third paid off, and a furniture account that shows as a credit card at about 50 percent use. My credit score is now 668, before all this goes through. What do you think I can expect?

Also, the original balance on the card used for transfers will take my payment first, and, by the time I get to the end of the promotion I will still be paying on that original balance. But the APR is still lower than on the transferred balances. Should I seek to transfer that balance at some point to get a better APR? Or would a new card or loan be better? – Diane

Dear Diane,
Despite all of your hard work reducing the credit utilization percentages (balance/credit limit) on most of your cards, and even though that $3,000 credit-limit increase may have helped slightly, I wouldn’t expect to see a score increase of more than a few points from this balance transfer.

If your score seems to be stuck in neutral at 668, consider that credit scores calculate your highly influential card utilization on both an individual and combined account basis. A high score requires low utilization on each card as well as in total.

That $3,000 limit increase may have dropped your combined utilization by a few percentage points at most. However, from the calculations that look at your cards individually, you have essentially swapped a bunch of cards with medium-level utilization (30-60 percent) for low utilization (under 5 percent) on all but one card that’s now maxed out. This is a recipe for more of the same score.

That’s not to say that you shouldn’t have taken advantage of that promotional low interest rate and transferred those balances. No doubt, you’re saving money on interest compared to what you were paying earlier, even if you haven’t helped your score much.

Yet it’s possible to save money on interest and raise your score via lower utilization without paying down what you owe. Perhaps you had an inkling of what I’m about to suggest with your last question that asks if you might be better off moving that debt to a new card or a loan.

The case for an installment loan
A new card can help your score if it comes with a high-enough limit to make a sufficient dent in the combined balance/limit equation. Unfortunately, your 668 score is probably too low to be approved for such a limit. A debt consolidation (installment) loan, on the other hand, has a lower score requirement and can be both cost-effective and score-raising by rolling all of your card debt into an unsecured personal loan with consistent monthly payments at a relatively-low interest rate over a fixed period of time.

There is a good reason why moving debt to an installment loan can help your score when transferring it to another card won’t. While credit card or “revolving” credit utilization ratios have a major impact on scores – almost 30 percent – the same cannot be said for installment loan utilization (current loan balance/original loan amount). As you may have already observed with the loan you’re currently paying, the amount of installment debt you owe – whether mortgage, auto, student, consolidation or other loan type – has little effect on credit scores.

In essence, converting card balances to an installment loan eliminates revolving utilization as a factor for that amount of debt. There are at least three ways in which moving that debt to a consolidation loan can be an excellent alternative to balance transfers:

  1. Pay less interest. A balance transfer may offer a lower interest rate, but you should also factor in its true costs, including the initial fee (usually 3 percent of the debt transferred) and high APR at the end of the promotional period. When you compare them with those of a consolidation loan over the remaining life of the debt, the consolidation loan tends to win out.
  2. Instantly raise your score. Well, maybe not instantly. But considering that a consolidation loan can lower both your individual and combined card utilization to as little as 0 percent within 30-60 days and possibly raise your score by 20 points or more, that’s about as close to an “instantly” positive score impact as you’re likely to see.
  3. Lower your monthly payments. Along with reduced APR and card utilization, consolidation loans tend to require lower monthly payments than credit cards for the same amount of debt.

Just don’t rack up more card debt
If a consolidation loan sounds too good to be true, for some consumers it just may be. The one big warning sign that applies to all of these consolidation loan advantages is that they only work if, after taking out the loan, you avoid running up any new card balances that cannot be paid in full each month. Otherwise, you could wind up with the worst of both worlds: a consolidation loan plus new credit card debt –  and a lower score.

Whether now or at the end of your current balance transfer promotional period, if you’re looking to raise your score as well as cut your borrowing costs, give a consolidation loan some thought.

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