Using a personal loan to pay off credit card debt is one option you might consider. This type of debt consolidation could help you save money on interest and pay off credit cards faster. Understanding how consolidating credit cards with a personal loan works can help you decide if it’s right for you.
Personal Loan vs. Credit Card Debt: What’s the Difference?
Personal loans and credit cards represent two different types of credit. So what is a personal loan? A personal loan is a lump sum of money you borrow and then repay, with interest. Personal loans can be secured, meaning they require collateral, or unsecured. Generally, if you’re talking about getting a personal loan to pay off credit card balances, you’re talking about an unsecured loan. A personal loan is a type of installment debt. You pay the balance down but you can’t add to it. A credit card, on the other hand, is a form of revolving credit or open-ended credit. You can borrow up to your credit limit by making purchases and as you pay them back, you free up available credit for use.
Benefits of Paying Off Credit Cards With a Personal Loan
There are some good reasons to consider using a personal loan to pay off credit card debt, especially if you’re struggling to gain traction with your current repayment method.
Streamline Debt Repayment
One of the most challenging things about carrying balances on multiple credit cards is simply keeping up with monthly payments. Consolidating credit cards using a personal loan means you have just one payment to make each month, rather than several. This can make managing your monthly budget easier. And you’re less likely to miss a payment due date and suffer credit score damage when you have just one payment to make.
Save Money on Interest
Taking out a personal loan to pay off credit card balances could potentially save you money if your loan’s interest rate is lower than the average rate you were paying on your cards. The average credit card APR for accounts paying interest was 17.13% in August 2021. Meanwhile, the average APR for a personal loan with a 24-month term was 9.39%, according to the Federal Reserve. If you have a reasonably good credit score, you may be able to qualify for a debt consolidation loan at a lower rate. This could save you money, and since more of your payment goes to the principal, you could also get out of debt faster.
May Improve Your Credit Score
Using a personal loan for credit card debt consolidation may also yield credit score benefits. Thirty percent of your FICO credit score is based on amounts owed across various types of accounts. One important factor when it comes to credit card debt is your “utilization ratio,” or the amount of your available credit limit you’re using at any given time. Getting a personal loan to pay off credit card debt could help to improve your credit utilization ratio since you’re zeroing out the balances on your cards. The key to making the most of this benefit is not increasing your utilization ratio by making new purchases with your cards—and by steadily paying down what you owe on the consolidation loan.
Downsides of Paying Off Credit Cards With a Personal Loan
While using a personal loan to consolidate credit card debt has some definite advantages, there are some potential drawbacks to consider as well.
You Could End Up With More Debt
One of the biggest risks with using a personal loan for debt consolidation is the temptation to use your cards for more spending. If you use a personal loan to pay off credit card balances, then run those balances up again all you’ve done is added to your debt pile. And you may hurt your credit score in the process if your credit utilization increases.
There May Be Fees
While many lenders offer personal loans without fees, not all of them do. You may pay a personal loan origination fee, for instance. Reading the fine print on personal loans can help you avoid any hidden or sneaky fees.
Savings Aren’t Guaranteed
Even though personal loan interest rates tend to be lower than credit rates, you’re not always guaranteed to save money. If you have a fair or poor credit score, then the personal loan interest rate you’re approved for may not be that different from the APR you’re paying on your credit cards. In that case, debt consolidation with a personal loan may not save you much, if anything, at all.
How To Use a Personal Loan To Pay Off Credit Card Debt
If you think getting a personal loan to pay off credit cards is the right move, it helps to have a game plan going in.
Choose the right loan. The first step in consolidating credit cards with a personal loan is finding the best loan option. Shop around and compare loan fees, interest rates, repayment terms, and qualification requirements from different lenders. Use loan funds to pay off debt. It may be tempting to spend that lump sum of cash, but remember your goal: paying off credit card debt. As soon as the loan proceeds clear your bank account, schedule payments to your cards to pay them off. Don’t add to your debt. Once your credit card balances are zero, consider putting them aside somewhere so you’re less likely to use them to make new purchases. If you’ve stored your card details online at your favorite stores or a mobile wallet app, you may want to delete that information. This way, you can stick to paying cash for purchases instead of credit. Pay off your loan early, if possible. Paying off a personal loan early can save money on interest and get you out of debt faster. Switching to biweekly payments, for example, could knock a few payments off the loan term.
Other Ways To Pay Off Your Credit Cards
Personal loans aren’t the only way to tackle your credit card debt.
Debt Snowball
The debt snowball method is a system for paying down debt according to the amount of the balance. You order your debts from smallest balance to highest. Then you pay as much as possible toward the smallest balance first while paying the minimums to your other debts. Once you pay off the first debt, you roll that payment over to the next debt on the list. You keep proceeding this way, snowballing payments until you’re left with one large payment going to the last debt on your list.
0% APR Balance Transfer
A balance transfer involves using one credit card to pay off another. This may mean paying a balance transfer fee. Balance transfers can save you money if your new card has a 0% APR. Keep in mind, however, that this APR typically only applies for a fixed period of time. Once the introductory APR ends, the regular variable APR kicks in.
Home Equity Loan or Line of Credit
A home equity loan is a loan that allows you to withdraw equity using your home as collateral. A home equity line of credit (HELOC) works the same way, only you’re getting a revolving credit line instead of borrowing a lump sum. Either one could be used to consolidate debt. Keep in mind, however, that if you default on a home equity loan or HELOC, you risk losing the property to foreclosure.
Negotiate Your Rate
You could try negotiating a lower interest rate with your credit card company to save money. Whether your credit card company agrees to reduce your rate can depend on your account history and card balance. But it’s worth making a call to discuss how you can make your debt more manageable.
Consider a Debt Management Plan (DMP)
If you’re struggling with credit card repayment, a debt management plan could help. This type of plan, offered by credit counseling agencies, allows you to make one payment toward your debt each month. The credit counselor then distributes your payment among your creditors. Debt management plans can save money if your credit counselor is able to negotiate lower rates or fee waivers on your behalf. You can also get out of debt sooner if you’re committed to making plan payments as agreed. Callout: Tip: When searching for credit counselors, be sure to look for a nonprofit agency that’s affiliated with a national accreditation agency.
The Bottom Line
Using a personal loan to pay off credit cards could speed up debt repayment while reducing the amount paid in interest. Whether debt consolidation makes sense for you can depend on your budget, spending habits and the interest rates you’re likely to be approved for with a personal loan. In addition to personal loans, you may consider other options for managing credit card debt, including a balance transfer offer or debt management.
