Credit Card Rewards Vs. Debt Consolidation: Which Saves More Money?

Every time I see another ad for an extra cash back or travel rewards card, I cringe. Bankrate surveys continue to show an uptick in the number of Americans carrying balances. A third have more credit card debt than emergency savings.

Despite the high level of debt, many consumers with credit card debt continue to chase after the “free money” and perks offered by travel and cash back credit cards. Bankrate credit card expert Katie Kelton suggests consumers are weathering a number of forces keeping them in debt: “I think the record-high number of Americans in credit card debt comes from the perfect storm of inflation, high interest rates and chasing rewards.”

The long-term damage that credit card debt can do — and is doing — to American households may be alleviated with a debt consolidation loan. If you plan carefully, you can stop carrying a balance and pay off your cards with a clear end date.

Are you really getting the full benefit of chasing credit card rewards?

According to data from Bankrate’s 2024 Credit Card Rewards Survey:

• 39 percent of credit card holders redeemed less than $300 in cash-back gift cards.
• 1 in 5 (22 percent) redeemed $300 or more.
• 23 percent didn’t redeem their rewards at all.

Stubbornly high inflation and interest rates may make it harder to pay credit card balances off monthly. Credit card holders may continue pursuing rewards and avoid the reality of growing balances.

“Some [people] might indulge in items they can’t afford or chase card rewards as a way to feel good and in control,” Kelton explains. “These small wins offer an endorphin boost that debt payoff doesn’t.”

What is the real cost of carrying credit to get rewards?

In the excitement of taking steps to capitalize on earning credit card rewards, it can be easy to forget the ripple effect that carrying a balance of revolving credit can have on future credit decisions. Every dollar you spend and don’t pay back on a credit card can increase your credit utilization ratio — a big driver of your credit score.

Even a 20-point drop in your score can have a major impact on your overall finances. For instance, if your credit score falls from good to fair, you will spend significantly more on other loans and insurance.

Here’s how your finances could play out: Assume you’re carrying $6,380 in credit card debt — the average for most Americans. If you, like many people, also have plans to refinance your home, buy a car and insure your purchases, carrying a balance will have a big effect on what you spend.

Your mortgage rate and homeowner’s insurance

For this example, assume a $300,000 mortgage with a standard 30-year term. The average mortgage rate for a borrower with good credit (680) is 7.55 percent, while the average rate for fair credit (660) is 7.61 percent, based on data from Experian.

• Good credit costs
  

  	Mortgage	Homeowners insurance
  Monthly payment	$1,686	$186
  Average annual cost	$12,236	$2,242
  Total interest paid	$367,082	–

• Fair credit costs
  

  	Mortgage	Homeowners insurance
  Monthly payment	$1,696	$199
  Average annual cost	$12,355	$2,390
  Total interest paid	$370,643	–

The difference between your monthly payments will be slim, about $10, but even a slight dip in your credit score will cause you to pay thousands of dollars more in interest on your mortgage. Your homeowners insurance policy will also see a rate hike of about $150.

Your auto loan rate and auto insurance

The impact of carrying a balance on your credit cards is even more severe if you want to take out an auto loan. A standard 60-month used car loan of $25,000 will have an average interest rate of 9.95% for good credit and a whopping 14.46% for fair credit.

• Good credit costs
  

  	Auto loan	Auto insurance
  Monthly payment	$531	$223
  Average annual cost	$1,367	$2,678
  Total interest paid	$6,834	–

• Fair credit costs
  

  	Auto loan	Auto insurance
  Monthly payment	$588	$245
  Average annual cost	$2,052	$2,934
  Total interest paid	$10,261	–

Auto loans are significantly more expensive if you aren’t in the good credit range. In this example, a fair credit score will mean a more expensive monthly payment and cost you about $4,000 more in interest. Your auto insurance rate will also be about $250 higher each year on average.

How a debt consolidation loan gets you out of the rewards red and into the savings green

A debt consolidation loan is an installment loan. You receive the entire amount you borrow as a lump sum and make a fixed monthly payment. Most importantly: If you use it to pay off revolving debt like credit card balances, your credit utilization ratio drops.

So let’s say you pay your rewards cards off with a debt consolidation loan, and your credit score jumps back above 680 before you tackle common financial goals like in the previous example.

To cover the average credit card balance of $6,380, you will need a $6,400 debt consolidation loan. The current average personal loan interest rate is 17.80 percent for credit scores between 630 and 689. With a five-year term, you will pay over $400 less than you would by making fixed payments over the same period on a rewards card.

If you only make minimum payments or continue to spend money on your credit card, the amount you pay quickly inflates. You can estimate how much you would spend on interest with a minimum payment calculator.

Debt consolidation loans get you off the credit card merry-go-round

In a perfect credit card reward world, you pay off your credit card balance before a cent of interest accrues, but there will always be bumps in the road. If you are unable to pay off your card each month, the consequences of carrying a balance — or several balances — may be reduced with a personal loan for debt consolidation. Plus, it comes with some extra perks:

1. It simplifies your bill paying. Tracking the payments and maximizing rewards on several cards is complicated, and as we all know, life happens. A debt consolidation loan gives one payment with a fixed interest rate and a term of one to seven years. That reduces the risk of a late payment, which could significantly tank your credit score.
2. It puts you on a debt payoff schedule. You can’t re-use the funds on a personal loan. It’s one and done, and when you make the last 12- to 84-month payment, the debt is gone.
3. It could give your credit scores a big boost. Any credit card balance affects your scores. The 30 percent target suggested by many finfluencers still leads to a lower score than getting your total available balances below 10 percent — or even better, paying them off entirely.
4. You can leave your savings account alone. If you’re like many Americans with very little savings, a debt consolidation loan allows you to leave what you have alone.

Bottom line

If I had my way, there would be a giant red warning label on every credit card with a rewards plan: “Misuse of credit card debt can lead to serious financial health problems.” Credit cards are a good tool for building your credit and collecting rewards, but if you find yourself stuck with balances on your rewards cards, you could end up paying average interest rates above 20 percent.

“Unfortunately, the cost of interest will end up outweighing any rewards you earn. If you can switch to a debit card or cash while paying off credit card debt, you’ll save yourself money in interest,” says Kelton.

However, if savings are low and balances are high, a debt consolidation loan could be your next best option. If used wisely, it may put you in better financial shape for future credit (and insurance) needs — and put you on the path to debt freedom.