Are you knee-deep in credit card debt, and you don’t know what to do about it? Fortunately, there are plenty of ways around your situation. One of the strategies you’ll often see is taking out a personal loan to pay off credit card debt.
But is it a good move? More importantly, is it the right approach for you?
In this article, we’ll discuss using a personal loan as a way of doing debt consolidation. We’ll explore the pros and cons of this method, and suggest other alternatives that you can try.
What Is A Personal Loan?
If you’re looking into loans to pay off credit card debt, one of the most common types you’ll encounter are personal loans. As the name suggests, this is a loan that you take out under your name. You usually borrow this from a bank, but several third-party lenders can also serve you.
A personal loan is a type of unsecured loan. That means you don’t need to put up collateral when applying. It makes it less risky on your part since you’re not putting any assets on the line. This shifts the risk more to the lender. That’s why personal loans have much higher interest rates, which can reach upwards of 35%.
Getting a personal loan to pay off debt can be a good option, assuming the interest rate is lower than your existing debt. This is usually the case when your credit score is good enough to warrant great rates.
You can then use the loan to pay off credit card debt, using repayment strategies like credit card refinancing, credit union debt consolidation, or credit card consolidation. All of these can help you clear your debt faster and often cheaper.
To consolidate credit card debt means you use the money you get from the loan to pay all your debts. That way, you only need to worry about paying a single loan. Lower interest rates mean you also pay less in the long run. To refinance credit card debt means replacing it with your personal loan debt in the hopes of paying lower interest rates.
Using a longer-term loan to pay off credit card debt can also be a viable strategy in certain situations, as it can lower the amount you need to pay monthly. Of course, the drawback is that you need to pay the loan over a longer period of time, and often the overall amount paid is more significant.
Personal loans are an excellent way to improve your credit score, assuming you pay your monthly payments in full.
Personal Loan Debt vs. Credit Card Debt
If you’re thinking of using a personal loan to pay off credit card debt, you might think what’s the point of it all. They’re both debts, so what’s the difference?
To start, personal loans are a type of installment loan. You pay a fixed amount every month until you fully return the money to the lender, plus interest. They’re very predictable, so you can easily save money every month to pay them.
The downside is that the amount is set – you have no option of paying less on certain months when you’re unable to.
Credit card debt, on the other hand, is a type of revolving fund. The amounts change depending on how much you spent that month. They’re also very flexible. As long as you meet the minimum amount set by the credit card company, you can pay only the amount your budget allows.
The caveat is that credit card interest rates are significantly higher than that of personal loans. They also carry hefty late fees and annual fees, which can tack on to your debt even further.
Left unpaid, the balance on your credit card bill can balloon uncontrollably. This is the reason why credit card debt is the number one consumer debt most Americans have. It’s so easy for someone to over swipe, and often without much thought.
The key with credit cards is to maintain a low balance every month, ideally 30% of your card’s total credit limit. This can improve your credit history, as well as make your bill manageable.
Potential Personal Loan Risks
Using a personal loan to pay off credit card debt might be a good idea, but is not without risks. The biggest drawback of this type of loan is that you’re tied up with a fixed monthly payment term for several months or years.
If your financial situation worsens and you suddenly find yourself unable to afford your loan payments, that can be a big problem. You can’t simply choose to pay a lower amount if you need to. There are no minimum payments to fall back on as you can with credit cards.
You’ll find that this arrangement might be a significant burden on your monthly expenses than you realize. This is because the amount you need to pay is often much more than the minimum amount required by your credit card.
Personal loans can also be very unforgiving if you fall behind. Miss just a few payments, and it will immediately harm your credit score.
Personal loans also have “hidden” fees that you need to be aware of. The most common are origination fees and handling fees. The former is a percentage of the total loan (around 6%).
When comparing different loan products, be sure to keep these fees in mind. They might be eroding any savings you’ll get when doing debt consolidation or refinancing. You might find that you’re paying the same (or worse, more!) in interest, which defeats the purpose of getting a credit card debt loan.
The bottom line is that when using a personal loan, you need to be more careful with your finances. Stick to your budget and make sure you’re able to pay the monthly loan dues.
Is A Personal Loan Right For You?
While it’s a solid choice, applying for a personal loan to pay your credit card debts isn’t going to be a good fit for everyone.
For one, if you can’t handle the risks involved (discussed in the previous section), a personal loan might do more harm than good. Your finances must be stable enough to make due on all your monthly loan payments, at minimum.
A personal loan is best used when you’re facing debt from multiple credit cards with various billing cycles and interest rates. Consolidating all of them into a single personal loan with one payment and interest is going to be a big relief.
Sometimes, consolidating all your debts is worth it, even if the new loan’s interest rate is roughly the same.
You should also check with the lender to see if their personal loans have a minimum borrowing amount, as many do. This usually ranges from $1,000 – $5,000. If your debt amount falls below this range, a personal loan might not be a good option for you.
Don’t ever make the mistake of borrowing more than you need to just for the sake of qualifying for a loan.
Personal loans also make sense if you have a good credit score to back you up. Having a mediocre credit history can give you higher interest rates on your loan, or you may not get approved at all.
Know Your Options
If a personal loan isn’t the right choice for you, the good news is that there are plenty of other strategies out there.
You can still do credit card debt consolidation without using a personal loan. One way is by using a balance transfer card, which has 0% APR. You can consolidate all of your credit card debt and transfer the balance to the card. This has the benefit of stopping added interest, so you can focus on paying it off.
Other methods you can consider include taking out a home equity loan or borrowing from family and friends. The advantages of these is consolidating your credit card debt without being penalized by high interest rates. You can avoid a personal loan altogether while zeroing out your credit card balance. The disadvantages, on the other hand, is digging yourself into even more debt in the long run.
However, if you’re serious about tackling your credit card debt, we recommend looking at debt relief. At CreditAssociates, we have experienced counselors who can come up with a customized debt repayment plan that’s an excellent fit for your situation.
We’ll take into account the amount of debt you owe, your financial goals, and your budget, helping you take the guesswork out of solving debt problems.
Once you’re back on track, debt counselors can even ensure you don’t fall back into debt ever again, as they can help you with budgeting and debt management.
Ready to tackle that credit card bill? Get in touch with CreditAssociates today and schedule a free one-on-one consultation with a trained debt counselor. We’ll find the best strategy for you, so you can get back on track and live a debt-free life again.