DRB Financial Series: How to tackle credit card debt
Editor’s note: This is the first article in a fall financial series of New Dentist Now blog posts from Darien Rowayton Bank, which provides student loan refinancing and is endorsed by the American Dental Association. Qualifying ADA members receive a 0.25 percent rate reduction to DRB’s already low rates for the life of the loan as long as they remain ADA members. View rates, terms and conditions and disclosures at student.drbank.com/ADA.
Did you rack up credit card debt when you were in dental school? Charge some big purchases to help get your practice off the ground? If you’re saddled with credit card debt on top of your dental-school loans and other normal living expenses, you’re not alone. The average American household has $15,000 in credit card debt.
While credit card debt may be common, it’s the most important kind of debt to get rid of. Any balances you carry on credit cards have much higher interest rates than mortgages or dental-school loans. Additionally, mortgages and student loans can be considered investments that will secure you future earnings, while credit card debt acts as a burden that weighs down your bank account and credit score.
Fortunately, there are two major weapons to attack your credit card debt and repair your financial standing.
#1 Balance Transfers
Frequently advertised by credit card companies, balance transfers allow you to move existing debt to a new card with a lower interest rate, sometimes zero percent, for a promotional period. This allows you to save potentially hundreds of dollars in interest payments. The opportunity to have zero percent interest means that you can focus on paying off the debt principal – not just the interest that accrues every month.
Balance transfers do involve a hard credit inquiry, which can affect your credit score. A balance transfer also requires you to open a new card. This will lower your average credit account length, which may also bring down your credit score.
Generally, promotional interest rates last only a year, after which you’ll probably return to paying a similarly high-rate as you did before the balance transfer. Some people think they can get around this by continuously applying for new balance transfer credit cards. Unfortunately, multiple balance transfers are a huge red flag to the credit bureaus and to lenders. Balance transfer cards not only can be time-consuming to keep track of when promotional periods end, but also difficult to continuously find new lenders to transfer your balance. Your credit score will definitely be impacted, and you’ll encounter higher rates on any other loans you need to take out, such as a mortgage. The savings from transferring $15,000 of credit card debt could be marginal when compared with a lower rate on a $700,000 mortgage.
In addition, if you plan on continuously transferring your balance, you run the risk of not finding a new lender at the end of the promotional period. This means getting stuck with paying the high credit card interest rate after the promotional period is over.
One thing to be mindful of is the fine print on balance transfers. Usually, any new charges you make on the card will not be eligible for the introductory offer – in other words, if you transfer your balance to a new card, and then use that card to make other purchases, you will be paying a high APR on that new purchase from the day you made it. That means you need to be extra diligent about always paying the balance on the new card. If you don’t, you could find yourself paying a higher rate than the old credit card that you were originally trying to get out of. Additionally, sometimes there are transfer fees as high as 3 percent! Assuming you’re transferring $15,000 of debt, that’s $450 alone on the cost of the transfer. As with all credit cards, keep an eye out for annual membership fees.
The bottom line: Under the right circumstances, balance transfers can be a good option. If you are certain that you can pay off your balance within the promotional period and don’t intend to make any major purchases on the new card, a zero percent balance transfer could save you a lot of money. You can pay off your debt quickly, not accrue interest, and your credit score will have time to recover before your next major expense, so use balance transfers strategically as part of a thoughtful financial plan.
#2 Personal Loans
Another option to reduce your credit card debt is to take out a personal or installment loan. A personal loan is a lot like any other bank loan. You apply for a certain amount, select a term length (how long you want to take to pay the loan off), an interest rate is calculated, and you make monthly payments for the duration of the loan. Typical installment loans are more straightforward than balance transfers. They have a set payment schedule and end date, you cannot redraw against them the way you can with a credit card, and you are not making purchases that can be charged at different interest rates. Like a balance transfer, a personal loan also involves a hard credit pull before the loan is approved.
One benefit of an installment loan is that it offers the opportunity to pay back debt over a longer period of time. Terms usually start around 3 years and can go up to 7 years. If you have a large sum of debt or if you intend to pay it off over the course of a couple of years, a personal loan may be a good choice.
Personal loans generally have more attractive rates than credit cards, but a higher rate than balance transfer promotional rates. At DRB, we offer personal loans created specifically for dentists with interest rates between 5.74 percent to 9.99 percent APR with no origination fees. (Note: Personal loan rates accurate as of Sept. 6, 2016.) Be sure to do your research online to compare personal loan rates should you be interested. Since credit cards charge rates between 16 percent to 25 percent APR, your savings potential is sizeable.
A side benefit of personal or installment loans: They offer the opportunity to establish a different type of credit, which can increase your credit score. Credit cards are revolving credit, whereas loans are installment credit. By demonstrating to lenders that you are capable of managing multiple types of credit, your score could see a boost.
Don’t forget to assess those risks: Remember though, personal loans are not for everyone. If you’re not sure you’ll be able to maintain the monthly payments for the duration of the loan, you’ll run the risk of defaulting, which will be a major blow to your credit score. Some personal loans also have origination (set-up) fees or closing costs, so keep an eye out for those.
The bottom line: Personal loans are good if you want to make a large purchase (e.g. dental practice loan, home improvement), need to consolidate already existing high-rate credit card debt, or want to pace out the repayment over a couple of years. With a personal loan, you have a structured method to pay back your debt over a multi-year period without having to worry about promotional rates expiring. The interest rate will be much lower than letting it sit on a credit card. If you successfully pay off the loan, you’ll also demonstrate that you can maintain a long-term payment schedule and your credit score will rise.
Either Way, Make a Plan and Stick to It
Both balance transfers and personal loans have pros and cons. You’ll need to assess your personal situation to determine which is right for you. If you can pay off your debt in under a year or the advertised promotional period, consider a balance transfer. If you know you’ll need longer than a year, consider a personal loan.
Either way, stick to the option you select and focus on paying down the debt in the allotted time and not incurring any new debt during that period. By clearing yourself of outstanding debt and not taking on any more, you’ll see your credit score rise and be offered more attractive rates on future loans.
DRB (Darien Rowayton Bank) is a national bank, marketplace lender and the fastest lender in industry history to reach $1 billion in student loan refinancings. FDIC insured and established in 2006, DRB Student Loan has helped thousands of professionals with graduate and undergraduate degrees across the country to refinance and consolidate federal and private student loans, saving these borrowers thousands of dollars each.