What’s the best way to pay off your debt? - KUAM.com-KUAM News: On Air. Online. On Demand.

What’s the best way to pay off your debt?

© iStockphoto / Lidija Tomic © iStockphoto / Lidija Tomic

By Andrew Housser

Nearly 40 percent of U.S. households carry debt on a credit card – and the average household that carries a balance owes more than $16,000. At interest rates of up to 20 percent annually, the burden can be significant.

If you are thinking about how to repay your debt as quickly as possible this year, you may be among the many people considering a balance transfer to another credit card or a personal loan to pay off the high-interest credit card debt. Which is the best option? Here are a few questions to help you decide.

1. What are your credit scores? Unless you have a FICO score of 700 or higher, you might not qualify for a balance transfer at a good interest rate. On the other hand, many independent personal loan lenders use different criteria than a traditional bank or credit union to evaluate how likely a person is to repay a loan. If you do not have spotless credit, but are financially responsible, you might have better results with a personal loan than a balance transfer.

2. How long will it take you to pay off your debt? Personal loans and credit card balance transfers usually charge a loan origination or balance transfer fee. For either a credit card or a personal loan, this fee may be 1 to 5 percent of the loan amount. If you can repay the debt within the time of the credit card promotional interest rate, the fee might cost less than the interest you would otherwise pay. For a loan, however, the cost of the interest you will pay plus the origination fee generally does not make sense for repayment terms of a year or less. For this reason, most debt refinance loans are issued for a period of 36 to 60 months.

3. Can you rely on yourself to pay more than the minimum? Most credit card balance transfers have an attractive promotional interest rate – often even zero percent. That interest rate is temporary, though. If you cannot pay off the debt in 12 to 24 months, the lender begins charging the going rate. Currently, the average interest rate on credit cards is about 16.35 percent. If you transfer a balance of $5,000, a minimum payment of 3 percent of the balance would be $150. If you pay only the minimum, you would have paid off only about $2,600 after 24 months, in part because the minimum payment gradually decreases as you repay the balance. When the promotional rate expires, the lender will begin charging interest. It would take nearly six more years to repay the balance, and you would pay an additional $1,100 in interest. To repay the full $5,000 in two years, you would need to pay $210 per month every month. A personal loan, on the other hand, has a set term. A loan of $5,000 for 24 months, with an interest rate of 10 percent, would require a monthly payment of about $230.

4. Do you have a plan to prevent your debt from recurring? Before you consolidate debt with a personal loan or transfer debt to a different credit card, evaluate your budget and your habits. How did you get into debt in the first place? Do you have a strategy to avoid getting into the same problem again? You may need to carefully evaluate your financial goals and priorities, learn to create and use a simple budget, and create a solid emergency fund. These steps may require earning more income through an additional job or odd jobs, or reducing your expenses or change habits to live within your means.

5. Are you planning to transfer your balance between two cards issued by the same lender? Most credit card lenders will not let people transfer balances between two cards from the same company. In this case, a personal loan might be your best option.

6. Can you make minimum payments on your current debt? If you are struggling to make minimum payments, neither a balance transfer nor personal loan may be the right option. If this is your situation, speak with a credible debt relief provider to discuss debt negotiation (settlement) or credit counseling.

Most importantly, do not mistake either a credit card balance transfer or a personal loan for getting out of debt. Both of these strategies are simply tools. You still must rely on a budget and your own commitment to successfully get out of debt.

Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.
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