Using a personal loan to pay off credit card debt has some significant advantages, as we will discuss below. However, it also comes with some rather significant considerations.
Let’s take a look.
What is a Personal Loan?
A personal loan, also sometimes referred to as a signature loan, or a good faith loan, is a type of loan issued by financial institutions secured only by your promise to pay. These loans can usually be applied to whatever use the borrower decides, without concerns from the lender. To decide whether to grant a personal loan, lenders will conduct a careful review of your income, credit history and credit score.
As you might imagine, you’ll need to look really good in all of those regards to qualify for such a loan. After all, the bank could be sticking its neck out pretty far, depending upon the amount you borrow.
On the other hand, in exchange for granting you this courtesy, the bank will also charge you a higher rate of interest that it would on a loan secured by collateral. Thus, in order to make using a personal loan to pay off credit card debt worthwhile, you’ll need to qualify for an interest rate substantially lower than the one you’re currently paying on your credit card debt.
Personal Debt vs Credit Card Debt
One of the advantages of personal debt over credit card debt is it is installment debt. Your interest rate is usually fixed as well. This means your payments will remain the same each month until the debt is paid in full. Installment debt is also closed out when the obligation is satisfied. You’ll need to apply again if you want another loan.
A key consideration of personal debt over credit card debt is you can count on the same monthly payment each month. Of course, that also means you’ll need to be certain you can afford to make the monthly payment before you agree to accept the loan.
Credit card debt is what’s known as revolving debt. You can borrow up to a set amount, pay it back on a month-by-month basis and borrow again as long as the account remains open, in good standing, and your loan balance is below your credit limit.
You also have the option of varying your payment each month, as long as you meet the minimum amount. However, credit card debt typically carries a higher interest rate than personal debt and it can go on and on infinitely, until you either stop charging things or close the account altogether.
Using Personal Debt to Pay Off Credit Card Debt
This brings us to how to consolidate credit card debt with personal debt, which is one of the most popular uses for a personal loan. You can torpedo several high-interest credit card debts this way, leaving you with one monthly payment, as opposed to a multiplicity of them.
You’ll be looking at a lower interest rates too. They are often charged to the tune of 20% or better for credit cards, compared to 10% or less for a personal loan. This can save you many hundreds, perhaps even thousands of dollars.
What’s more, using a personal loan to accomplish this might even boost your credit score. You’ll add variety to your credit mix, which accounts of 10% of your score. Your credit utilization will go down too as you pay off the personal loan.
Caveats to Consider
There are many advantages to using a personal loan to pay off credit card debt. However, it’s important to remember that personal loan will only shift your debt from one place to another.
You’ll still owe the money, so be careful not to let those zero balance credit cards tempt you into using them again until the personal loan is paid off.
Along those same lines, it’s a good idea to get a handle on why you wound up with so much credit card debt in the first place — and taking steps to avoid a repeat. Otherwise, you could wind up worse off than you were before.