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 taking 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, apply for a personal loan might be helpful. But a personal loan also offers other advantages.
1. You can benefit from a lower interest rate
You can pay 20% APR or more if you have a credit card balance, although borrowers with great credit can pay around 12% to 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 than if you have a high credit rating. This means that you could cut your total interest payment in half and even pay off your debt sooner because you will be paying less interest.
2. Consolidation simplifies payments
If you make a lot of 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 could face late fees and your credit score could drop.
By taking out a personal loan to consolidate your credit card payments, you will be making one monthly payment on your loan rather than multiple payments. Reducing the number of payments can free up time and space for other responsibilities.
3. You could increase your credit score
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 credit you use to the 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 good use of credit and can help improve your score.
4. You can pay off your debt sooner
If you only make minimum credit card payments every month, it could take you years, or even 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. 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 restart the cycle by replenishing 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 an increase in 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 balance transfer credit card.
2. You are not guaranteed 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 outstanding credit, you may not be eligible for a personal loan. If you are eligible 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, such as late fees, creation costs and insufficient fund charges, for example. Keep this in mind when you compare personal lenders.
How to choose the best personal loan
There are many personal lenders that charge different interest rates and fees, and offer various 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:
- 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 owe 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 are 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 higher your credit score, the more loans you can qualify for with no set-up 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 a lot out of it. Each lender offers different minimum and maximum amounts. Along with this, your credit score could have an impact on the amount you are allowed to borrow. The higher your credit rating, the more trustworthy you are with 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 works best for your finances.
Credit card balance transfer
You may be able to apply for a new credit card that allows you to transfer existing credit card balances, maybe like lower interest cost for you. 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 the balance at 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 the minimum payments each month. If you don’t, you risk losing 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 struggling with your new card balance and all the old cards that carry the remaining balances.
Snowball or avalanche debt
You can also decide on the best way to settle your credit card debt by concentrating the additional payments on one of your cards. There are two main ways for people to do this: either snowball or debt avalanche method.
The benefits of using any of these methods include:
- Avoid new lines of credit. If you don’t have high credit or don’t want to take on additional 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 focuses on paying off debt with the lowest balance first. 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 doesn’t work with it. If your budget is already tight, you may not have the extra money to invest in higher credit card payments.