Credit cards may be convenient, but they also represent one of the most expensive ways of going into debt. If you have built up an ongoing balance on some or all of your cards, you should consider ways of refinancing that debt into cheaper alternatives.
Marketplace lenders, which match investors with borrowers online, have added a new wrinkle to the line-up of credit refinancing alternatives. In any case, the key is to choose an alternative that can be part of the solution to your debt problem, and not simply an addition to it.
Credit card refinancing alternatives
Unlike many interest rates, credit card rates have not dropped much in recent years, and can easily exceed 20 percent for consumers with weaker credit ratings. That can rapidly add to your debt problem if you have built up a balance you cannot readily pay off. If you are wrestling with that kind of high-cost debt, the following are some cheaper alternatives you might consider:
- Prioritizing your credit cards. This is a simple first step for anyone carrying regular card balances: make sure to carry those balances on the card with the lowest rate, and choose that card first for any new purchases. This can save you some money, but is a limited approach because if you are carrying heavy credit balances, you are likely to find all the rates you pay on those balances relatively expensive.
- Balance surfing. This is the practice of repeatedly shifting balances to new credit accounts to take advantage of zero-percent initial rate offers. Two pitfalls to watch out for here: balance transfer fees can undermine the apparent savings from these moves, and opening too many new accounts could hurt your credit rating, resulting in higher rates in the long run.
- Home equity. Home equity loans, home equity lines of credit, and cash-out refinancing are all ways you could refinance credit card debt at a much lower interest rate. Naturally, these all depend on your having equity in your home that you can borrow against, but the big potential downfall is that all of these approaches use your home as collateral. That means you have to be confident of repayment or else you will be putting your home at risk.
- Traditional bank loans. Federal Reserve figures show that personal loan rates often run three full percentage points below credit card rates. However, getting a personal loan is likely going to depend on having some collateral to put up, and that entails a similar caveat to using home equity - failure to repay could mean losing your property.
- Marketplace lenders. Non-traditional lenders using online technology to match investors with borrowers represent part of the evolution of peer-to-peer lending. However, while peer-to-peer lending originally matched individual proposals with people to fund those proposals, marketplace lenders are increasingly using automation to assess creditworthiness and bundle loans to manage risk. On the other side of the ledger, large banks and other institutional investors are quickly taking the place of individuals as the funders for these loans. With this evolution still in process, expect this source of credit to be highly changeable over the next few years. New credit markets often attract enthusiastic investment in their early years, when yields are still relatively attractive and the reality of long-term default rates has yet to set in. Eventually, a backlash often causes investors to pull back, and a recession could also cause funding to dry up. Still, while this may not be the most stable source of credit in the years to come, in the meantime it could represent a cost-effective alternative for borrowers.
Making it work long-term
Think of lowering the interest rate on your debt as easing one of the symptoms, but to actually cure the problem you need to work towards eliminating that debt. Therefore, you should only undertake any of these refinancing solutions as part of a disciplined budgeting effort that includes a pathway for paying down your debt. Otherwise, the risk is that refinancing simply becomes a way of enabling more debt, by freeing up credit limits for new borrowing.
The goal of eliminating debt should help you choose which refinancing alternative is right for you. In many situations, the approach which gets you out of debt fastest should be the most cost-effective approach in the long run. Otherwise, if you cannot map out a realistic pathway to eliminating debt through refinancing, then you need more serious financial assistance before you commit to any credit refinancing approach.