Debt happens, and it can sneak up over time. Next thing you know, you’re buried in high-interest credit cards debt with no idea how to dig yourself out. Fortunately, you may be able to refinance your credit card debt to get lower interest rates or fewer monthly payments, which can help you become debt free more quickly and pay less interest.
Does refinancing hurt your credit? We’ll cover options to refinance credit card debt and their potential impacts on your credit score.
Like a mortgage or a car loan, credit card debt can be refinanced to help save on interest or get out of debt quicker. But unlike mortgages and auto loans, there are multiple avenues for refinancing credit cards.
You might refinance your credit card debt through a debt consolidation loan, a line of credit, a home equity loan or even with balance transfer credit cards.
A debt consolidation loan offers you the opportunity to pay off some or all your credit cards with a single personal loan. Generally, a debt consolidation loan has a lower interest rate than credit cards, potentially saving interest charges. These loans are designed to reduce multiple monthly payments to just one monthly loan payment, streamlining the debt-repayment process.
Debt consolidation loans are available from a wide range of lenders, including banks and credit unions, as well as those that specialize in debt consolidation.
There are two ways a debt consolidation loan may affect your credit score: the initial impact and the long-term impact.
The initial impact may be a slight decrease in your FICO credit score. You must first go through a credit check when you apply for the loan, which places a new hard inquiry on your credit report and will typically lower your credit score by fewer than five points.
A new loan may also have a negative impact on your length of credit history, which accounts for 15% of your FICO score.
After the initial credit score decrease, you may see a longer-term credit score increase — potentially a dramatic one — for a few reasons.
First, your credit utilization ratio accounts for 30% of your FICO credit score, and installment loans, like a debt consolidation loan, aren’t considered when calculating your credit utilization ratio.
If you pay off a large amount of credit card debt with a debt consolidation loan, you’ll see a substantial drop in your credit utilization ratio. Because credit utilization is the second-highest factor in calculating your FICO credit score, you could see a significant credit score increase.
Second, refinancing your credit card debt into a debt consolidation loan can affect your credit mix — the different types of revolving and installment credit accounts you have — which is responsible for 10% of your credit score. Having a mix of credit types and being able to manage them well is seen as a positive factor by creditors.This could lead to a small increase, but an increase nonetheless.
A line of credit is another way you might be able to refinance your credit card debt. It’s similar to a debt consolidation loan, in that one loan — and just one monthly payment — is used to pay off multiple credit cards. However, unlike debt consolidation loans, which are installment loans, lines of credit are revolving debts, meaning you can use them multiple times until you reach the credit limit, much like a credit card.
Two common types of lines of credit used to refinance credit cards are the personal line of credit and the home equity line of credit (HELOC).
A personal line of credit, which Tally offers, requires no collateral and generally offers an interest rate that’s lower than those of your credit cards.
A HELOC allows you to take out a line of credit against the equity in your home. The equity is the difference between your home’s value and your outstanding mortgage amount. Most lenders won’t allow you to take a HELOC out on 100% of the equity — they’ll generally limit you to 80% to 90% of the equity, depending on the lender’s policies.
For example, if your home is worth $300,000, and you have a $250,000 mortgage balance on it, you have $50,000 in equity. Most lenders will offer you up to a $40,000 HELOC ($50,000 x 80%).
However, HELOC lenders generally only allow you to use the line of credit for a specified period, known as the draw period. After the draw period ends, you can no longer use the HELOC, and you enter the repayment period.
Because a HELOC is backed by collateral – your home – it often has a very low interest rate and longer repayment terms than an unsecured loan, which may result in lower monthly payments. A major drawback to using your home as collateral is the risk of foreclosure if you don’t repay the debt.
Does Refinancing With a Line of Credit Hurt Your Credit?
Because a line of credit is revolving debt, FICO treats it like a credit card and includes it in your credit utilization ratio. So unlike a debt consolidation loan, you won’t see a possible credit score increase due to a lowered utilization ratio. On the contrary, adding a new revolving account to your credit report can cause your score to decrease slightly.
However, a lower interest rate can make it easier to pay down the balance faster, potentially improving your score quickly.
If you are willing to put your home up as collateral for a loan, but don’t want or need a line of credit, a home equity loan may be an option. Unlike the revolving credit of a HELOC, a home equity loan is an installment loan, and the funds can only be used once.
Another similarity to HELOCs is that lenders generally limit a home equity loan to about 80% of the home’s equity.
Because it’s an installment loan, a home equity loan will have similar impacts on your credit score as those of a debt consolidation loan. You may see an immediate credit score decrease due to the new loan and new credit inquiry appearing on your credit report.
However, rolling your revolving credit card debt into this installment loan is designed to reduce your utilization ratio and can potentially increase your credit score.
Financing a credit card balance with another credit card may not seem like the most logical way to become debt free. However, with balance transfer credit cards, you can potentially save big on interest charges if the card offers a promotional APR.
With a balance transfer card, credit card debt is transferred from one or more high-interest credit cards to a new credit card that offers 0% APR during a promotional period, usually 6-18 months. After the promotional period ends, the balance transfer card’s interest rate converts to a standard credit card interest rate.
While the 0% interest is enticing, it’s important to remember that these cards often charge a 3-5% balance transfer fee. That’s not much compared to the average credit card interest, but it’s worth considering.
Also, while lines of credit and debt consolidation loans often have repayment periods of three or more years, a balance transfer card’s 0% interest promotional period usually lasts only 6-18 months, making them short-term refinancing options.
Unless you already have a balance transfer credit card, you’ll have to apply for one, which will include a hard credit inquiry. This can result in a slight credit score decrease. Plus, adding a new credit account can reduce the average age of your credit history, also potentially lowering your score slightly.
On the flip side, since you’re adding a new credit card with available credit, you’ll reduce your credit utilization ratio and potentially increase your credit score.
Credit card refinancing may sound like the perfect personal finance solution, but it’s not for everyone. If you fall into one of the below categories, refinancing may not be a good option for you.
Impulse spending is what gets many people into credit card debt in the first place. Once you refinance your credit card debt and have a $0 balance, one impulse could end in you reaching for the plastic again, piling new credit card debt on top of your freshly refinanced debt.
If you’ve struggled with this issue in the past, you may be better off using the debt avalanche or debt snowball method to repay your credit card debt. Using one of these methods could help you get out of debt without the temptation to use the available credit limit you’ve freed up by refinancing.
Most credit card refinancing options require a good credit score to get approved. If you have a spotty payment history, too many credit inquiries, a high credit utilization ratio or any other credit issues, you may not get approved.
When you refinance your credit card debt through a HELOC, home equity loan or debt consolidation loan, you’ll often pay lender fees. Different lenders have varying fee structures, but they can sometimes reach into the thousands of dollars.
If you have the surplus cash needed to pay off your credit card debts quickly using the debt avalanche or debt snowball methods and avoiding these fees, it may be a better financial decision to skip refinancing and pay them off with cash.
When thinking about refinancing credit cards, there are different avenues you can take to hit your goals. The main options include:
- A debt consolidation loan.
- A line of credit.
- A home equity loan.
- A balance transfer card.
Each option has its pros and cons, but determining if refinancing will hurt your credit will depend on which option you choose.
With any of these choices, you’ll have to add at least a single inquiry to your credit report, which may result in a small credit score decrease. From there, you could see credit score increases, depending on your financial situation, as each option may reduce your credit utilization ratio.
The key to refinancing your credit cards isn’t the immediate impact on your credit score. Instead, it’s a longer-term plan that can ultimately result in significant credit score increases. So focus on getting your debt under control, whether that’s through refinancing or another means, and watch as your credit score steadily rises over time.