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A good understanding of the differences between balance transfer and personal loan

The Difference Between a Balance Transfer vs Personal Loan

If you’ve taken on too much credit card debt or have simply fallen behind on credit card payments, taking on a personal loan or balance transfer plan could offer a way out. Unlike credit cards with interest rates that can add up to a significant amount, personal loans or balance transfers have lower interest rates, making them the ideal option to repay your debts.

But how do you decide which is best for you? Deciding between a balance transfer and personal loan in a time of need can leave you pulling hair out of your head, but with a good understanding of the differences between the two, you may be able to make a more informed decision based on your specific need. This article will break down the two types of loans, as well as address the commonly asked questions around them. It’s important to note that the figures stated in this article are merely examples and not actual figures or percentages.

Understanding balance transfers and personal loans

The best way to decide between the two types of loans is by breaking them down individually. This section will explain what a balance transfer and personal loan is.

Before moving on, it is worth noting that when we look at balance transfers and personal loans, keep in mind that there are two types of interest rates – the advertised rate (AR) and the effective interest rate (EIR). The AR depicts the loan interest rate on its own without taking any additional fees into consideration. On the other hand, the EIR includes the total fee. To illustrate, if you take on a S$5,000 loan with an advertised interest rate of 5% p.a., you’d expect to pay S$250 in total interest. However, if the bank charges an additional administration or annual fee of S$199, this means that the actual interest you are paying for will be S$449, which is approximately 17% p.a. in effective interest rate. In Singapore, banks and financial institutions are required to provide this information upfront but if you don’t see it on the brochures, make sure to ask.

What is a Balance Transfer?

A balance transfer is as the name suggests. It allows you to transfer your remaining outstanding balance to another bank at a much lower, or sometimes even 0% interest rate over a fixed period of time, which is often offered by banks to new customers. Of course, there may be processing fees involved which would impact the EIR, but if you make your repayments on time on the new card, you can avoid traditional credit card interest rates that can be as much as 29.9% p.a. Taking on a balance transfer plan on a  credit card essentially buys you more time to pay off the loans without worrying about paying high interest.

Do keep in mind that since the purpose of a balance transfer plan is to pay off existing credit card debt, most financial institutions will not allow you to take on a balance transfer plan to pay off a card from the same bank. Some financial institutions also allow you to transfer the funds to a bank account in case you are consolidating the outstanding on more than 1 credit card.

How does it work?

Balance transfer plans are often offered in 3, 6, or 12-month repayment periods, and require you to pay a minimum amount (about  2.5 or 3% of your remaining outstanding balance) each month. At Standard Chartered Bank, this amount can be as low as 1%. In the final month of the balance transfer loan period, you are expected to pay off the remaining amount in full.

This means that you can transfer the money you owe on an existing card onto a balance transfer plan on another card to buy some time. As an example, let’s say you have a total debt of S$6,000 on your credit card. Instead of having to fork out this sum in one payment, you can ease your cash flow and buy time to repay this amount over 12 months on a balance transfer plan, where you will be required to pay a minimum of S$300 (5% of the S$6,000) each month, until the last month where you would pay the remaining outstanding balance of S$3,413, plus the additional processing fees which varies according to the plan that you signed up for. If you choose not to pay the remaining outstanding balance, interest would be charged and you will have to continue to service the minimum amount due until the outstanding balance is paid off.

Having a 12-month timeframe will force you to pay off your debts quicker, but it should also be more achievable since you won’t fall into the vicious cycle of being hit by a high interest rate month after month. A balance transfer also allows you to consolidate debts from multiple credit cards into one, so it is easier to manage all your debts and pay them back on one card/account. Basically, a balance transfer card is a second chance, with a fixed timeline.

Just remember that you can only enjoy the benefits of a balance transfer if you have a good repayment plan in place and stick to it. Otherwise, the promotional interest rate-free period can be revoked and interest can soar even before the end of the repayment period, putting you back in the same place as you were before.

Another thing to note is that the amount you are allowed to borrow from a balance transfer plan will be bound by the credit limit of your existing credit card. This means that if you are entitled to a S$10,000 credit limit for an existing credit card, the bank will allow you a balance transfer of up to 95% of the credit limit, which is S$9,500. However, this means that you are only left with a total of S$500 each month to spend on that credit card.

What is a Personal Loan?

personal loan is an unsecured loan. It allows the funds to be disbursed to your bank account of choice except credit cards or other personal loans.  What’s more, you can choose to pay off your loan at your own pace, over a tenure of up to 5 years.

How does it work?

Personal loans often offer a lower interest rate compared to credit cards. It is therefore a good tool to use for credit card outstanding balance consolidation, as it can be stretched over a longer tenure at a much lower monthly repayment amount. This would ease cashflow on a monthly basis. While personal loans do offer a lower interest rate, it still charges a monthly interest rate, unlike balance transfer plans that charge a one-time fee instead.

Most banks will allow you to borrow up to four times your monthly income if you meet the minimum income requirement for a personal loan. However, it is advisable to borrow only what you need, and everything you borrow will have to be paid back. The amount of loan you take will also have to be paid back over a fixed tenure. Of course, you have a choice to repay your loan earlier or extend the repayment period if required. Just note that there may be fees involved for such requests.

Is 0% interest really 0%?

On paper, yes, but in reality, it is very unlikely. Balance transfer plans will offer a 0% interest for a specific period of time. However, this does not mean that there are no fees involved. While the bank may not charge interest for the duration of your loan (unless you are late on the minimum payment required), you will have to pay for a processing fee on the approved transfer amount.

For personal loans, some lenders may offer a 0% interest loan, but with a higher processing fee.  Be sure to check with the service providers on any fees that you are paying for. They may not be stated as “interest rates” but could be categorized under administrative or processing fees. So your best bet would be to reference the advertised EIR before selecting a loan.

Impact on your credit score

A credit score tells your level of creditworthiness. It is a way for financial institutions to assess your risk as a credit applicant. As a general rule, the more money you owe, the      more your credit score will be affected. However, if you do it the right way, you can minimize the impact of your credit score.

Essentially, credit scores are a reflection your payment behaviour. Late or delinquent payments often have significant impact on your scores, which affects your overall creditworthiness. This is why it is important to always pay the amount owing on time and be consistent about it, whether it is a balance transfer or personal loan.

It is difficult to say whether your credit score will be improved by repaying your debt, since it encompasses all other forms of credit you have, such as your housing, car, even student loans. Ultimately, the point to note is that as long as you have a prompt repayment plan in place, a balance transfer or personal loan should not impact your credit score negatively in the long run.

If you would like to find out what your credit score is, you can request for a report from the Singapore credit bureau for a small fee.

Which one should you choose?

Since balance transfers and personal loans can sound similar in nature, this table highlights the key differences between the two. Keep in mind that both plans will require you to have a proof of income.

Essentially, your decision should depend on your ability to repay the sum borrowed. If you think you need a longer period of time to pay off the loan and are able to pay it all off within a fixed period of time by setting a good amount of money aside each month, then a personal loan is a more structured and disciplined way to pay off your outstanding balance. However, if you need to buy yourself more time, then the balance transfer plan may be a wise choice, although not for too long. It will simply allow you to stretch the repayment period for a few more months while you work out a solution.

Choose wisely

Balance transfers are not necessarily superior to personal loans, neither is the reverse true. It all boils down to the circumstances you are in. If you have a proper financial plan laid out and are able to pay off the balance transfer in the “free” credit period, the balance transfer option may be better because you have more flexibility in the repayment amounts each month.

Otherwise, taking a personal loan may be the more comfortable option as you would be able to stretch the loan period longer, some up to five years or more. Just remember that once you commit to a personal loan, try to keep to the timeframe of that loan. Paying back the loan ahead of time or asking for an extension can incur additional fees.

Whether you decide to take on a balance transfer plan or a personal loan, be prepared to pay back within the stipulated time frame. Don’t look at balance transfer plans or personal loans as a quick way out. While they can provide you with some breathing space, be sure to pay up on time or you may actually end up in a worse place than you were before, landing yourself in a vicious cycle of debt.

The table below helps further break down the differences between them:

Balance Transfer
Personal Loan
Processing period Can be approved immediately for online applications Can be approved immediately for online applications and cash can be withdrawn
Duration of loan 3, 6, or 12 months Up to 5 years
Repayment amount As low as 1% until the final repayment month where the full balance has to be paid From Applied Rate (AR) of 3.5%, or ~7% Effective Interest Rate (EIR).

The amount set for monthly repayment is fixed until the end of the loan period

Usage Primarily to pay off credit cards and personal loans that are incurring high interest rates, but can also be used for other purposes Can be used for any purpose. This includes  paying off your outstanding credit cards, used as an education fund, for medical purposes, even for a wedding.
Criteria Requires proof of income and credit score will be assessed. Up to 95% of the credit limit on your credit card will be allowed. Takes into account all other credit on you, where if combined, a total of up to 12 months of your total income is allowed Requires proof of income and credit score will be assessed. Takes into account all other credit on you, where if combined, a total of up to 12 months of your total income is allowed

Disclaimer

This article is for general information only and it does not constitute an offer, recommendation or solicitation to enter into any transaction. This article has not been prepared for any particular person or class of persons and it has been prepared without regard to the specific investment or insurance objectives, financial situation or particular needs of any person. You should seek advice from a licensed or an exempt financial adviser on the suitability of a product for you, taking into account these factors before making a commitment to purchase any product. In the event that you choose not to seek advice from a licensed or an exempt financial adviser, you should carefully consider whether the product is suitable for you. You are fully responsible for your investment decision, including whether the Online Trading service is suitable for you. The products/services involved are not principal-protected and you may lose all or part of your original investment amount.