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Should you use a personal loan to pay off your credit cards? We’ll give you the pros and cons, a few examples, and help you decide if a personal loan is right for you.
Credit cards make it easy to pay for purchases and earn rewards on your spending, but there are risks to consider before you get in the habit of paying with plastic. Not only do you run the risk of falling behind on your bills and hurting your credit score or racking up fees, but credit makes it far too easy to rack up debt people can’t afford to pay off. This is evidenced by recent data from The Federal Reserve, which shows that revolving debt (which includes credit card debt) had far surpassed $1 trillion dollars by the end of February 2020.
Many experts say the best way out of credit card debt involves cutting up your credit cards, switching to a cash budget, and using the debt snowball or debt avalanche method to destroy your balances as quickly as you can. However, I’m not entirely convinced that the “hard way” is the only way. After all, some consumers can use some help getting out of debt, including the benefit of a much lower interest rate.
Using a Personal Loan to Get Out of Debt
Normally, I don’t suggest people take out loans. There are situations, however, in which a loan can help you pay off debt and save money along the way. This is definitely the case for consumers who have credit card debts with exorbitant interest rates and cannot seem to get ahead because they’re still using credit cards. In cases like this, ditching plastic and consolidating debt with a personal loan can absolutely pay off.
With a personal loan, borrowers can qualify for a fixed amount of cash with a fixed interest rate, monthly payment, and repayment date. This means they can borrow the amount they need to pay off their credit cards, use the cash to pay off their balances for good, then make the fixed payment on their personal loan until they’re out of debt. Of course, the key to this strategy is making sure you stop using credit cards to rack up more debt!
Why are personal loans so advantageous when it comes to getting out of debt? And why shouldn’t you just keep making payments on your credit cards instead? The answer depends on the interest rate you can qualify for and the fact that credit cards come with an average APR of more than 16 percent.
Consider this example that shows how a personal loan could pay off:
Let’s say you have $4,000 in credit card debt on a Chase Sapphire Preferred Card, which could easily come with an 19.99% APR. If you were able to pay $150 per month, you could pay off this debt in 36 months — or three years — but you would pay $1,333 in interest along the way.
However, with the goal of saving money, you decide to apply for a personal loan through Credible, a loan marketplace that lets you compare loan rates and offers from multiple lenders using a single platform. After submitting your information with Credible, you discover that you could qualify for a personal loan from SoFi with an APR of 5.99% for three years. With this loan, you could pay just $122 per month for 36 months — meaning you’d pay only $380 in interest over that timeline.
That’s just an example, but imagine how much savings you could accrue if you had tens of thousands of dollars in high-interest debt. Keep in mind that many companies who offer personal loans let you borrow up to $40,000 for debt consolidation, so the difference could be life-changing.
How to Find the Right Personal Loan
If you have debt, as most people do, a personal loan can help you get a fresh start while you craft a plan to pay it off. Still, you should spend some time making sure you’ll wind up with the right personal loan for your needs. Here are some tips that can help:
- Check Your Credit Score. Most lenders in this space offer their best rates and loan terms to consumers with good or excellent credit, although you can normally get a good deal if your credit and income are at least average. Having an idea of what your credit score is before you apply can help you know where you stand.
- Compare Multiple Lenders. We mentioned how Credible lets you compare multiple personal loans in one place, but you can also check out rates individually from lenders such as LendingClub, LightStream, and Payoff. While many lenders offer competitive rates, it’s possible one option will be lower than others. Rates are typically based on your credit score and other factors.
- Watch Out for Fees. While many lenders do not charge any fees for personal loans, some do charge an origination fee. Make sure you check what, if any, fees a lender charges — you might be surprised at what you find. Also give precedence to lenders such as SoFi, LightStream, and Marcus by Goldman Sachs, since they don’t charge origination fees or other hidden fees on personal loans.
Should You Consider a Balance Transfer Credit Card Instead?
We like that the best personal loans allow you to make a fixed monthly payment with an interest rate that will never change, but there is one alternative we think might work better in some cases. With a balance transfer credit card, you can secure a 0% APR on transferred balances for up to 21 months. The catch is, you typically have to pay an upfront balance transfer fee that usually works out to 3% or 5% of your balance.
Consider the example above and how that might work with a balance transfer credit card. If you owed $4,000 and signed up for a balance transfer card that let you avoid interest for 21 months with a 5% balance transfer fee, you would start your debt repayment journey with a $4,200 balance. However, you would have 21 months with no interest, meaning you could pay $200 per month on your credit card during the entire introductory period and end up debt-free when the offer came to an end.
This makes the balance transfer card less expensive than a personal loan, but you have to keep in mind that balance transfer credit cards aren’t for everyone. For some people, another credit card just means more open credit and more opportunity to rack up debt. In those cases, a personal loan can be a smarter option if it allows you to stop using credit and stick to cash or debit instead.
Is a Personal Loan a Good Idea?
For some reason, personal loans tend to come with a stigma that credit cards don’t. However, I actually think they can be hugely beneficial when it comes to paying off debt. For starters, you can’t pop them in your wallet and use them to keep making purchases. Plus, a fixed monthly payment and interest rate means you’ll never be surprised by how much you owe in a given month. You’ll also know exactly when you’ll be debt-free with a personal loan, which can be a major motivator in your journey toward debt freedom.
So, should you get a personal loan? While some people need to get out of debt the hard way, sometimes personal loans and balance transfer credit cards can help. Your personal comfort level and commitment will help determine which course of action you should take.
Have you gotten out of credit card debt with a personal loan? Share your story with us below!