If you are struggling to figure out how to pay off credit cards, one option is to take out a personal loan. By using a loan to pay off debt, you can consolidate your cards into one fixed monthly payment and make those payments more manageable.
This payment option isn’t for everyone and comes with its own limits or drawbacks. However, by understanding the nuances of getting a credit card loan, you could take the first steps to reduce your overall debt.
Using a Personal Loan to Pay off Credit Card Debt
When you use a personal loan to pay off credit card debt, you typically apply for a loan through your bank or another financial provider. With this loan, you pay off multiple debts with the principal of the loan and then start paying off the loan directly. The single personal loan ideally has a better interest rate and lower monthly payments than the ones you just paid off. Once you have finished paying off the personal loan, the account closes.
There are a few things to know about using personal loans for your credit card debt that can guide your research as you learn more about your options.
- Personal loans are installment loans, which means you will pay a fixed monthly payment over the course of your term, which typically ranges from a few months to a few years. This differs from credit card payments, which can fluctuate more or less as long as you hit the minimum monthly payment.
- Personal loans can either be secured or unsecured. An unsecured loan doesn’t use collateral, like a home or car, to reduce risk to the bank. The nature of the loan may impact the interest rates and terms offered to you.
- Along with your interest rates, you may also need to pay extra fees on the loan based on the financial institute you work with.
These various components can help you understand the terms offered in your personal loan by your financial provider.
Benefits of Using Personal Loans to Pay off Credit Card Debt
Of the various options to pay off your credit card debt, taking out a personal loan has significant benefits if you are looking for a structured payment plan that doesn’t change over time. The benefits of this payment model reflect the stability of payment plans laid out in a personal loan.
- Personal loans consolidate your cards into a single payment.Instead of negotiating with multiple credit companies to start payment plans or lower minimum payments, you will only need to make one payment per month.
- Along with a single payment, a personal loan also has a fixed term; this differs from credit cards, which stay open until the debt is paid off and the users close them. Once you pay off your loan and the interest, the contract ends.
- Personal loans tend to have lower interest rates than credit card offers. They also usually have fixed interest rates, which means you will pay the same interest amount throughout the course of your loan. Conversely, some credit card companies use variable rates – like the prime rate that is published in the Wall Street Journal. You could see your interest rates increase even as you keep paying off your credit cards, making the payment process more expensive than you expected.
For context on average interest rates, the average credit card interest rate hovers around 16%, while some personal loans are approved for as low as 6%. Interest rates this low are typically only for borrowers with excellent credit.
Drawbacks of Using a Personal Loan to Pay off Credit Card Debt
While paying off credit card debt with a personal loan may work well for some people, this form of debt consolidation isn’t for everyone. There are a few precautions to consider with paying off your debt in this manner.
- Most personal loans required a minimum loan amount of $1,000 – $5,000. This only makes them a viable option if you have several thousand dollars of credit card debt to pay off.
- Personal loans may come with additional fees that make paying off your credit card more expensive than you plan on. The interest is just the first cost of the loan. By thoroughly reading the terms of your loan, you can better understand what you will be paying for it.
- There is also a chance that your personal loan will impact your credit score. Lenders will need to check your credit before approving you for a loan, and this inquiry could lower your score by a few points. Then, if you miss a payment on your personal loan, your credit score could drop more.
The fixed payments that some people appreciate when taking out a personal loan may be a drawback for other borrowers. A fixed payment means that you cannot pay less than the set amount each month, whereas a credit card may have more flexible minimum payments that you can pay if you are short on funds.
Factors to Consider When Using Personal Loans to Pay Debt
Because everyone’s financial situation is unique, there is no cookie-cutter solution for reducing debt. However, there are a few criteria you can review to understand what your situation looks like. These questions can guide your decision-making process and help you consider whether a credit card loan is the best option.
- Do you qualify for a personal loan? Will this even be an option if you can’t get a loan?
- Can you borrow enough to pay off your debt? If you can only borrow $5,000, but you owe $10,000, then you could end up paying your credit card debt and your loan at the same time.
- Will the term of the loan take longer to pay off? While taking out a personal loan can reduce your expected monthly payments, you may be in debt longer as you pay off the loan. Consider how long you expect to pay off your cards compared to how a personal loan would affect that.
- Do you want to close the credit card or keep it open? Closing your credit cards to consolidate your debt can reduce the temptation to spend more and make the problem worse. However, it also limits your available credit and your balance-to-limit ratio, which can affect your credit score.
- Will you save money on a personal loan? Will the interest rates and fees be less than what you are paying now?
All of these questions follow one common theme: will taking out a personal loan, make your financial situation better or worse? If you can’t pay off the loan or the loan is more expensive than your credit card debt, then it may not be the right option for you.
Other Options to Reduce Credit Card Debt
Taking out a personal loan isn’t the only way to reduce your credit card debt. One option is to look for a credit card with a low promotional APR or a 0% APR for the first year. Then you will transfer the balance from one card to the next. This is known as a credit card balance transfer, and you may need to pay a fee to transfer your debt; however, if you can pay off this card before the promotional APR ends, you can reduce the number of credit cards you have and pay off your debt.
Other options to pay off your credit card debt include taking out a home equity loan or a home equity line of credit (HELOC) or taking out a 401(k) loan. Home equity loans and HELOCs are based on the value of your house. While you may get a lower interest rate on this loan, you could lose your house if you can’t make your payments.
Similarly, a 401(k) loan comes from the money you have invested in your retirement. This can set back your retirement planning, but the loan does not show up on your credit report. While you may have several years to pay back this loan, you will only have 60 days if you lose your job.
Pay off Your Debt to Build a Healthy Financial History
Consolidating your debt can help you pay off what you owe. With lower debt, you may receive better terms for financial products in the future. Paying off your credit card debt with a personal loan is one option to achieve this, and may be a good option based on your financial needs.