Carrying high-interest credit card debt can feel like an endless cycle of barely making minimum payments while interest continues accruing. This traps many people in debt for years without making much progress on the principal balance.
If this sounds familiar, you may have considered taking out a personal loan to consolidate and pay off your credit card debt. While this strategy has its merits, it also comes with risks to weigh. This guide explores the pros and cons so you can make an informed decision.
How Personal Loans Can Help With Credit Card Debt
A personal loan essentially allows you to swap existing unsecured debt for a new, lower-cost unsecured loan. Instead of juggling multiple credit card payments at double-digit interest rates, you make one predictable payment each month to pay off the loan over a fixed term.
The key advantage of using a personal loan to consolidate credit card debt is the potential to save money on interest. Here’s why:
Lower Interest Rates
While the average credit card APR hovers around 20%, a personal loan with good credit can feature a rate as low as 5% to 8%. This means more of your payment goes toward principal rather than interest each month.
For example, $10,000 of debt at 20% APR costs over $2,000 a year in interest. At 10% APR, that drops to around $1,000 annually.
Fixed Payments
Personal loans feature fixed interest rates and payment amounts over a set repayment term such as three to five years. This consistency helps with budgeting rather than variable credit card rates fluctuating based on market conditions.
Set Payoff Date
By consolidating multiple credit card balances into a single loan, you’ll have a clear finish line indicating the exact date your debt will disappear for good through regular payments. No more wondering when you’ll ever escape.
Potential Credit Score Improvement
As you pay down a fixed-rate installment loan like a personal loan, your credit utilization ratio drops since you’ve eliminated revolving credit card balances. This can boost your credit score over time.
What to Consider Before Getting a Personal Loan
While paying off credit cards with a personal loan offers benefits, it also involves notable drawbacks:
Not Actually Reducing Debt
A major risk with personal loan consolidation is failing to change the habits that led to credit card debt in the first place. If you still overspend and rack up new card balances, a consolidation loan only hides the problem temporarily.
Accruing More Debt
Similarly, taking on a new loan adds to your total debt load. If you default on the personal loan, your financial situation worsens having to still repay credit card companies.
Origination Fees and Prepayment Penalties
While personal loans feature lower rates than credit cards, some charge origination fees upfront or penalize you for paying off the balance early. Factor these costs into comparisons.
Credit Score Impact
The hard inquiry when applying for a personal loan causes a small, temporary drop in your credit score. Also, a new account lowers the average age of accounts on your report. Both could negatively impact your credit.
Requirements for Approval
To qualify for the best personal loan rates, most lenders require a minimum credit score over 670 along with steady income over $40,000 per year. If your credit needs improvement, focus on other options first.
Eligibility Not Guaranteed
Even with good credit, approval isn’t guaranteed. The lender reviews factors like your debt-to-income ratio and may require collateral if they consider you high risk for default. Make sure to compare multiple lender offers if you decide to apply.
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Alternatives to Pay Off Credit Card Debt
Here are other strategies to attack credit card debt instead of taking a consolidation loan:
Balance Transfer Card
Opening a balance transfer credit card lets you shift debt onto a new account to benefit from a 0% introductory APR for over a year in some cases. Just be sure to pay off the full amount before regular interest kicks in.
Debt Avalanche Method
The debt avalanche route involves listing debts from highest to lowest interest rate, then putting any extra cash after minimums toward the most expensive balance first. Once that card is paid off, shift focus to the next highest rate.
Debt Snowball Method
With the debt snowball, you list debts from smallest to largest balance then attack the smallest debt first while making minimums on the rest. Knocking out these “quick wins” helps build momentum to tackle larger debts.
Debt Management Plan
If you require structured help, a nonprofit credit counseling agency can set up a Debt Management Plan (DMP) organizing consolidated payments to creditors at reduced interest rates. Fees apply but can save money long term.
Key Questions to Ask Before Paying Off Credit Cards With a Personal Loan
Before pursuing a balance consolidation strategy, ask yourself these important questions:
Will I Qualify for a Lower Rate Based on My Credit Score?
Interest savings only happen if the personal loan rate proves lower than your current credit card APRs. Review the average rates for your credit score tier first to set proper expectations.
What Fees or Prepayment Penalties Would Apply?
Accounting for lender origination fees, early payoff charges, or late penalties gives a more accurate projection of total loan costs and savings versus sticking with credit cards.
How Long Would It Take to Repay the Consolidation Loan?
Run the numbers, comparing your projected repayment timeframe for the loan amount versus individual credit card payoffs. The longer time horizon makes sense if the interest savings prove substantial.
Will My Income Cover the New Loan Payment?
Calculate what portion of your monthly income would apply toward the consolidated loan payment based on the amount you need to take out. Does this align with lender DTI requirements for approval?
Can I Avoid Racking Up New Credit Card Debt?
If paying off cards with a loan won’t curtail spending habits fueling your debt, it only masks the underlying problems temporarily before finding yourself still struggling.
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What to Do Once You Pay Off Credit Cards With a Personal Loan
Let’s assume you determined a debt consolidation loan made the most financial sense to escape credit card debt. Here are critical steps once your new personal loan distributes funds to pay balances:
Destroy and Freeze Credit Cards
Once cards show $0 balance from the loan payoff(s), physically cut up cards and freeze accounts temporarily as you adjust non-credit spending habits. This prevents temptation to accumulate new debt before the loan repayment finishes.
Automate Minimum Loan Payments
Set up autopay through your bank account so the fixed personal loan payment processes each month. This prevents missed payments resulting in late fees or credit score damage.
Budget Without Credit Reliance
Adapt your household budget to spending only what actual income allows by using cash, debit, or budgeting strategies without depending on credit cards short term. Treat loans as temporary until repaid.
Pay More Toward Loan Principal
If possible every month, contribute any extra income toward the debt consolidation loan principal on top of the minimum due. This accelerates the payoff timeline to reduce interest fees.
Reassess Credit Card Rewards
Once you pay off the entirety of the consolidation loan, reconsider if you still want to use credit cards for convenience or rewards. If so, commit to paying statement balances in full each billing cycle to avoid repeating past debt pitfalls.
To Recap
As challenging as it may seem when trapped in credit card debt cycles, maintaining realistic expectations offers the keys to success when considering balance consolidation loans or alternative payoff plans.
The math needs to work in your favor based on income, credit standing, and repayment term to realize interest savings without further spiraling debt. Revolving credit card temptation also requires diligence to avoid perpetuating the problem.
With accountable planning centering around your unique financial situation, paying off credit card debt permanently presents an achievable mission to pursue.
Frequently Asked Questions
How much does a personal loan lower your credit score?
Personal loans require a hard credit check so your score drops a few points initially when applying. Over the loan term, however, your score typically rebounds as you pay down principal and credit utilization declines.
Can you get approved for a personal loan with bad credit?
Yes, lenders offer personal loans tailored for bad credit scores below 640. But interest rates prove significantly higher so consolidate credit card debt at your own caution. Improving your credit first saves substantially on interest costs.
What credit score do I need for the lowest personal loan rates?
According to the Fed, applicants with credit scores above 670 qualify for the most favorable personal loan rates below 10% in many cases. Boosting your credit score even higher before applying saves you the most money.
Should I use a 401k loan to pay off credit card debt?
While 401(k) loans avoid credit checks and upfront fees, they put retirement savings at risk if you lose your job before repaying since the balance comes due immediately. Only use 401(k) loans as a very last resort compared to other options.
What is the fastest way to pay off credit card debt?
The debt avalanche method offers the fastest road to credit card debt freedom. List all debts from highest interest rate down, pay minimums on all cards, and put any extra cash toward paying off the most expensive balance first before shifting payments to the next highest rate.
Does getting a personal loan hurt my credit?
Opening a new credit account for a personal loan results in a hard inquiry, lowering your score a few points initially. But as you repay loan principal every month, your credit utilization drops, which boosts your score over the loan term. Just avoid missing any payments.
How many personal loans can I have at once?
Most lenders allow you to hold two (in some cases, three) personal loans simultaneously, depending on income level and debt-to-income ratio. But every new loan makes financial management increasingly complicated. Consolidate multiple debts into one if possible.
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