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Loans vs credit cards – what’s the best way to get debt-free?

One of the most common reasons people take out personal loans is in order to help their deal with existing debts, be they on other loans or on credit or store cards.

But a rise in the need for this kind of debt consolidation has led to the introduction of a new kind of credit card, known as a balance-transfer card. This allows borrowers to move debts from one card to another in the hope of cutting their interest bills.

So how do balance-transfer cards stack up against personal loans when it comes to consolidating debts?

1. What debts can you deal with?

Balance-transfer cards generally only allow you to clear debts you’ve run up on credit cards. With a personal loan, on the other hand, the money you borrow is delivered into your bank account so you can use it to pay off any kind of borrowing, such as another loan or a current-account overdraft.

2. The interest rate you pay

Many of the leading balance-transfer cards advertise long initial interest-free periods, and it is here they have an advantage over personal loans, which are more likely to charge a fixed, albeit relatively low, rate of interest.

However, the best rates on credit cards are reserved for borrowers with clean credit histories. And there are a number of strings attached to balance-transfer cards’ low rates…

3. Changes in rates

If you have a zero-interest balance-transfer deal, check the small print very carefully: if you miss a repayment, for example, your lender could revoke the 0% offer and charge you its standard rate of interest – often around the 20% mark – instead.

In some cases, simply using your balance-transfer card for spending or for cash withdrawals could see the 0% deal pulled.

4. Extra charges

Watch also out for any charges for paying your card bill late, or failing to pay the minimum monthly amount (normally 2% or 3% of the total debt). Some loans impose similar charges for late payment – setting up a monthly direct debt or standing order should help you avoid them.

And loans may also impose early repayment charges, but not all lenders do this.

5. The size of debts

You are likely to find that the limit on the amount you can borrow is lower on a card than on a loan. Credit limits for new card customers are more likely to be set at or below £5,000, whereas with a personal loan you can borrow well in excess of £10,000 if your lender permits it.

6. Paying off your debt

For most borrowers, consolidation is hopefully a way of clearing their debts. The advantage of a loan is that, provided the monthly repayments are met, whatever money you have borrowed will be paid off by a fixed date. With loans, the discipline needed to become debt-free is effectively a built-in feature.

With credit cards, on the other hand, it is up to the customer to make sure that the debt is cleared before the 0% period ends, if possible. If not, the lender’s standard interest rate will kick in and interest bills will quickly mount.

Find out more about Zopa debt consolidation loans