There are some important advantages to using a personal loan to pay off credit card debt, as we’ll discuss below. However, it also comes with some rather important caveats.
A personal loan, sometimes called a cosigner loan, or a goodwill loan, is a type of loan issued by a financial institution that is secured only by your promise to pay. These loans can usually be put to any use the borrower decides, without concern for the lender. Lenders will carefully review your income, credit history and credit score to decide whether to grant a personal loan.
As you can imagine, you’ll need to look really good in all of these respects to qualify for a loan like this. After all, the bank can stick its neck out pretty far, depending on the amount you borrow.
On the other hand, in exchange for giving you this insight, the bank will also charge you a higher interest rate than on a secured loan. Thus, in order to use a personal loan to pay off credit card debt, you have to qualify for a significantly lower interest rate than what you are currently paying on your credit card debt.
Credit Card Debt vs Personal Debt
One advantage of a personal loan over a credit card loan is that it is an installment loan. Your interest rate is also usually fixed. This means that your payments will remain the same every month until the loan is paid off in full. When the liability is fulfilled, the installment loan is also closed. If you want another loan, you will need to reapply.
One of the main advantages of a personal loan over credit card debt is that you can count on the same monthly payment every month. Of course, this also means that you should be sure that you can afford the monthly payments before accepting the loan.
Credit card debt is what is known as revolving debt. You can borrow up to a fixed amount, pay it back on a month-to-month basis and as long as the account is open, in good standing, and your loan balance is below your credit limit.
You also have the option to change your payment each month, as long as you meet the minimum amount. However, credit card debt usually has a higher interest rate than personal debt and can continue until you stop charging things or close the account entirely.
Using Personal Debt to Pay Off Credit Card Debt
This brings us to how to consolidate credit card debt with a personal loan, 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 many of them.
You will also be looking at lower interest rates. They often charge 20% or better for credit cards, compared to 10% or less for personal loans. This can save you hundreds, maybe even thousands of dollars.
What’s more, using a personal loan to cover this can also boost your credit score. You’ll add variety to your credit mix, which makes up 10% of your score. When you pay off personal loans, your credit utilization will also decrease.
Caveats to Consider
There are many benefits to using a personal loan to pay off credit card debt. However, it is important to remember that a personal loan will only transfer your debt from one place to another.
You still owe money, so be careful that those zero balance credit cards don’t tempt you to use them again until the personal loan is paid off.
Along those same lines, it’s a good idea to understand why you racked up so much credit card debt in the first place — and take steps to avoid it again. Otherwise, you could end up worse off than before.