Navigating credit card debt may seem like an endless uphill battle. As you grapple with multiple payments and sky-high interest rates, it’s easy to get discouraged and overwhelmed. However, one potential solution you can use is to get a personal loan.
One of the more prevalent applications of personal loans is credit card debt consolidation. Using the funds from a personal loan to pay off your credit card balances can make your debt more manageable. That said, personal loans come with pros and cons. We’ll take a look at the advantages and disadvantages of using a personal loan for credit cards and how the process works.
- Personal loans are a type of installment debt that allows borrowers to make a single monthly payment instead of multiple credit card payments.
- With a personal loan, you can potentially pay off your credit card debt faster, get a lower interest rate, streamline your loan payments, and boost your credit. However, personal loans are still debt, and you are not guaranteed a lower interest rate.
Personal Loan vs. Credit Card Debt
Although personal loans and credit cards are both forms of debt, one may be less costly than the other. A personal loan is an installment loan a borrower can use for anything from paying for a vacation to unexpected medical bills to credit card loan consolidation. Your monthly payment is fixed depending on how much you initially borrow.
On the other hand, credit cards are a type of revolving debt where your minimum monthly payment depends on how much you spend. Credit cards generally have elevated interest rates ranging from 12% to 30%+. The average credit card interest rate as of August 7, 2023, is 24.69%. Personal loans usually have lower interest rates, ranging from 4% to 36%, with the average rate hovering at 11.48% as of May 2023.
Here are some of the key differences between personal loans and credit cards.
- Fixed interest rates: Your interest rate is set when you take out the loan.
- Fixed repayment schedule: You may be able to choose your repayment term, which could range from 2 to 8 years depending on the lender and your loan offers.
- Origination fees: Some lenders charge an origination fee and other miscellaneous fees for taking out a personal loan.
- Set Monthly Payment: Because your repayment schedule and interest rates are fixed, you will make the same payment every month and know exactly when you will pay off the loan. This helps you plan your budget better, though you will have less flexibility to make lower payments when money is tight.
- Variable Interest Rates: The interest rates for credit cards are variable, meaning they can change over time in either direction.
- No Set Payoff Date: You must make at least the minimum payment each billing cycle, but you don’t necessarily need to repay your entire balance. While this gives you flexibility, if you don’t stay on top of your debt, your balance could snowball due to interest, making it harder to get out of debt.
- Different Fees: Some credit cards include an annual fee and other usage-based fees, such as late fees or balance transfer fees. For example, recently, I paid the $250 annual fee for my American Express Gold Card.
4 Reasons to Use a Personal Loan to Pay Off Credit Card Debt
1. You Can Pay Off Your Debt Sooner
If you have high credit card balances and you’re only making the minimum payments each month, it could take years to pay off your debt due to the interest costs. With a personal loan, you can wipe out your credit card balances immediately by consolidating them into one loan.
While you are essentially replacing one form of debt with another, personal loans tend to have fixed monthly payments and terms, making your repayment schedule more predictable and easier to manage. This switch can give you peace of mind and stability while you continue tackling your debt.
2. You’ll Probably Get a Lower Interest Rate
With credit cards, you could end up paying 20% or more on your balances, depending on the type of cards you own and the lenders. Although personal loans are not interest-free, you can generally expect the interest rates to be lower than those of credit cards. The best terms and conditions are even better if you have excellent credit. Depending on the lender, you could potentially cut your interest payments in half or more, enabling you to pay off your debt faster.
3. You Can Streamline Monthly Payments
Tracking multiple credit card payments each month can be time-consuming. Even with only 4 credit cards, I occasionally lose track of my payment due dates. When you miss a payment or pay late, you will get charged a late fee. Plus, your credit scores may take a hit.
Personal loans let you consolidate your debt into one fixed monthly payment amount, making it easier to plan ahead and set aside money for your debt. But, ideally, you should keep your credit cards open even if you pay off the balances. The average age of your credit plays a role if your credit scores, so if you close an older account, your credit score may fall because the average age of your credit falls.
4. You Could Boost Your Credit Score
Taking out a personal loan will trigger a hard credit inquiry and temporarily ding your credit score by a few points. But it also increases your credit mix, one of the main factors that go into your credit scores. Having a mix of credit shows lenders that you are responsible with money and know how to handle different types of debt.
Additionally, you will lower your credit utilization by paying down existing debt and opening a new line of credit. Your credit utilization ratio is how much of your available debt you are currently using. If you pay off your credit cards, your utilization decreases, ideally below 30%, which will help boost your scores.
4 Drawbacks of Paying Credit Cards With a Personal Loan
1. Personal Loans Are Still Debt
Remember that while you can use a personal loan to pay off existing credit card debt, that does not mean you are debt-free. You still need to pay off your personal loan and make monthly payments without incurring more credit card debt in the debt repayment process.
2. Avoiding Using Your Credit Cards May Be Difficult
If you can handle paying off your credit card balances in full every month, you can continue using your credit cards even after you’ve paid off existing debt with a personal loan. However, if you have trouble keeping your expenses in check and covering your balances, it’s best to avoid using your credit cards altogether.
This can also be a sign you are overspending or not making enough to afford your current lifestyle. In that case, the personal loan acts more like a band-aid than a long-term solution to your financial troubles.
3. Low Interest Rates Are Not Guaranteed
Just because personal loans typically come with lower interest rates than credit cards, that does not mean you will necessarily qualify for a lower rate. If you have poor credit, lenders may be reluctant to give you the best terms in case you default on your loan. Additionally, there is no guarantee that you will qualify for a large enough loan to fully pay off your credit cards.
4. Personal Loans Come With Fees, Too
Some personal loan lenders may also charge fees for opening a personal loan. Origination fees could be as high as 10%, potentially negating some of the benefits of getting a personal loan. Additionally, lenders may have late fees, insufficient funds fees, and other miscellaneous fees. Keep this in mind as you shop around because the fees could potentially cost more than the savings you would get.
How to Pay Credit Card Debt Using a Personal Loan
1. Apply For a Personal Loan
Before applying for a personal loan, shop around with different lenders and get prequalified to get a better idea of the rates and terms you can qualify for. In particular, check the annual percentage rate (APR), monthly payment amount, and length of the loan. Depending on your credit and payment history, some lenders may offer you a better deal than others.
Once you’ve decided which lender to go with, apply for the loan. You may need to meet certain eligibility requirements and gather documents to prove your financial situation and identity. If you get approved, your lender will send you the funds directly or apply it to your credit card debt.
2. Pay Off Your Credit Card Debt
Usually, the creditor will deposit the funds from your personal loan directly into your bank account. In that case, use the money to pay off all your credit card balances immediately. Avoid misusing your funds since that can put you in even more debt. Once you’ve paid off your credit card debt, you can take a breather before tackling your personal loan debt.
3. Pay Off Your Personal Loan As Soon As Possible
Once you’ve paid off all your credit cards, focus on paying off your personal loan. Sign up for autopay so you won’t miss any payments. If you have the means, you can even pay off your personal loan early and save money on interest. But check first to see if there are any early payoff penalties.
4. Spend Below Your Means
You don’t have to give up using credit cards forever, but you should be more mindful of your purchases moving forward. Only use your credit cards for purchases you know you can afford. That way, you can reap the benefits of using credit without putting yourself in too much debt.
How to Choose the Best Personal Loan
As you shop around for personal loan options, here are some things you should consider:
- Interest Rates: Like with most loans, your credit score plays a factor in the interest rate you get. Typically, lenders will offer the lowest interest rates to individuals with excellent credit. The higher your credit score, the lower your monthly payment and the less interest you’ll have to pay.
- Repayment Terms: Some lenders offer repayment terms as short as 6 months while others are 5 to 7 years. If you want to pay off your loan faster, look for a creditor who offers shorter repayment terms. If you would rather keep your monthly payments low, find a lender who offers longer repayment terms.
- Fees: Most personal loans come with various fees. If you don’t have the best credit, look for lenders that don’t charge a ton of fees. Otherwise, you may end up paying more than you’d like on your loan.
- Loan Amount: Different lenders offer different minimum and maximum amounts you can borrow. If you have a higher credit score, you’ll appear more trustworthy to lenders, allowing you to borrow more.
The Bottom Line
Whether you are considering getting a personal loan for your credit card debt or weighing an alternative option like a balance transfer credit card or credit counseling, compare all your options beforehand. Ensure the personal loan you are considering offers lower interest rates than your credit cards, and create a plan to pay off your personal loan if you choose this option.