Pros and Cons of Using a Personal Loan to Pay Off Credit Card Debt – Forbes Advisor
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People use personal loans for many different reasons, from buying an RV to paying medical bills, but consolidating your credit card debt can be one of the most popular uses. By using the proceeds of a personal loan to pay off credit card debt, you can eliminate multiple monthly high interest card payments and consolidate the debt into one monthly personal loan payment, often at a reduced cost.
There are benefits to using a personal loan to pay off a credit card, but it’s not always the best option for everyone. Before choosing a personal loan to pay off your credit card, make sure you know the pros and cons.
4 benefits of using a personal loan to pay off credit card debt
If your goal is to get out of debt faster than you could by simply making the minimum monthly credit card payments, applying for a personal loan might be worthwhile. But a personal loan also offers other advantages.
1. You can earn a lower interest rate
You could pay an APR of 20% or more if you have a credit card balance, although borrowers with great credit can pay around 12-17%, depending on the type of card they have.
Personal loans, on the other hand, charge an average interest rate of less than 10%. The best personal loans are even cheaper if you have a high credit score. This means that you could cut your total interest payments in half and even pay off your debt sooner since you will be paying less interest.
2. Consolidation streamlines payments
If you make many different credit card payments each month, it can be difficult to keep track of all due dates and minimum amounts owed. If you miss a payment or don’t pay at least the amount owed, you may have to pay late fees and your credit score could drop.
By taking out a personal loan to consolidate your credit card payments, you will make a single monthly payment on your loan rather than several payments. Reducing the number of payments can free up time and space for other responsibilities.
3. You could increase your credit score
Although taking out a personal loan triggers a rigorous credit check and temporarily affects your credit score, a personal loan can positively impact your credit score in several ways.
Taking out a personal loan increases your credit mix, which represents 10% of your score. It shows creditors and lenders that you are responsible for the money by carrying many types of credit and debt.
You will also reduce your use of credit by paying off your debt. Your credit usage is the ratio of the amount of credit you use to the amount of credit you have. If you pay off your credit cards, your usage will drop to 0%. Less than 30%, and ideally less than 10%, is considered a great use of credit and can help improve your score.
4. You can pay off your debts sooner
If you only make minimum credit card payments each month, it could take you years, if not decades, to pay off your balances, depending on how much you owe.
With a personal loan, you can pay off your credit card debt immediately and set up a payment plan to pay off your personal loan only. The terms vary depending on the amount you are borrowing and your lender. If you were on track to pay off your credit cards in 10 years, you could take out a personal loan and pay it off in less than five years. Just make sure you don’t start the cycle over by rebuilding credit card debt.
3 disadvantages of using a personal loan to pay off credit card debt
There are potentially negative consequences to consolidating credit card debt by taking out a personal loan, including the cost. Also consider these drawbacks before making a decision.
1. Taking out a personal loan could lead to more debt
A personal loan means you borrow more money. If you take out a personal loan to pay off your credit cards and start having a balance on those credit cards again, you are accumulating more debt than before.
A personal loan for credit card consolidation is not a debt eliminator; only use it if you’ve used other options like increasing credit card payments each month or opening a credit card with balance transfer.
2. You are not assured of a lower interest rate
Personal loans tend to offer lower interest rates than credit cards, but this may not be the case for everyone. If you don’t have stellar credit, you might not qualify for a personal loan. If you qualify for a personal loan with bad credit, your interest rate may not be lower (and could be higher) than what you are currently paying.
3. Personal loans also have fees
Some lenders charge many different fees like late payment fees, origination fees, and insufficient funds fees, for example. Keep this in mind when comparing personal lenders.
How to choose the best personal loan
There are many different personal lenders that charge different interest rates and fees and offer different repayment terms. There isn’t a set of standards that personal loans follow, which means you can see a wide range of offers depending on what you’re eligible for. When exploring personal loan options, consider the following:
- Interest rate. The best personal loans will offer the lowest interest rates to those with the highest credit scores. The higher your credit score, the lower your monthly payment will be and the less interest you will have to pay over the life of your loan.
- Terms. Your repayment terms also vary widely depending on the lender. Some offer repayment terms as short as six months, while others range from five to seven years. If you want to pay off your loan sooner, find a lender that offers shorter repayment terms. If you need to lower your monthly payments, see if you can find a lender with longer repayment terms.
- Fresh. The better your credit score, the more you can qualify for loans that do not charge origination fees or other fees. If you don’t have good credit, assess each lender’s fees and see which ones you’re comfortable with in case you need to pay them. For example, if you miss a payment, is the late fee $ 15 or $ 30?
- Amount of the loan. Some people don’t need to borrow a lot to pay off their debt, while others need to take on a substantial amount. Each lender offers different minimum and maximum amounts. Along with this, your credit score could affect how much you are allowed to borrow. The higher your credit score, the more you trust lenders, allowing you to borrow more.
Alternatives to a personal loan
While a personal loan is a great option for debt consolidation, it’s not the only one. Go through all of your options to see which one is best for your finances.
Credit card balance transfer
You may be able to apply for a new credit card that will allow you to transfer balances from existing credit cards, perhaps to lower your interest charges. The benefits of a credit card balance transfer include:
- Payments without interest. If you qualify for a 0% APR balance transfer, you will not pay any additional interest charges for the promotional period, which would allow you to pay off your balance at a lower cost.
- No balance transfer fees. Most credit cards charge a fee when you transfer a balance, but you can find a few that waive the balance transfer fee.
- New advantages. If you have decent credit, you may be eligible for a new card that offers cash back rewards, travel benefits, or other types of offers for cardholders.
The disadvantages of a credit card balance transfer include:
- Possible interest charges. If you do not pay off the balance by the end of the promotional period, you may have to pay interest on the remaining balance.
- Loss of promotional offer. Even if interest doesn’t accrue, you are still responsible for making minimum payments each month. If you don’t, you could lose your promotional offer and interest will start to accrue on your entire balance.
- Missing qualification requirements. If you don’t have decent credit, you might not be eligible for a new line of credit card.
- Not having a high enough credit limit. Even if you qualify, your entire balance may not be transferred because the card issuer offers you a lower credit limit than you need. This means that you are responsible for the balance of your new card and any old cards that carry the remaining balances.
Snowball or avalanche debt
You may also decide that the best way to settle your credit card debt is to concentrate the additional payments on one of your cards. There are two main ways to do this: either by the debt snowball method or by the debt avalanche method.
The benefits of using any of these methods include:
- Avoid new lines of credit. If you don’t have a lot of credit or don’t want to take on more debt, these methods allow you to focus on paying off your debt with what you have, without increasing your burden.
- Focus on high interest. With the Debt Avalanche method, you pay off your debt first with the highest interest rate. It could save you more money in the long run.
- Focus on small wins. The debt snowball method first focuses on paying off the debt with the lowest balance. If you need a quick win, this could be your best bet.
Of course, these payment methods also have their drawbacks. You can find :
- It is a slow process. Increasing your payments with only the money you currently have means you can pay off your debt more slowly than a personal loan.
- Your budget does not work with it. If your budget is already tight, you might not have the extra money to spend on higher credit card payments.