A rare silver lining to the Covid pandemic was Americans managed to pay down billions of dollars in credit card debt.
Those days have screeched to a halt.
Credit card debt has skyrocketed again thanks to inflation and the end of government aid programs. Consumers are groping for relief. Here are two words of advice:
Consider getting one. Now, two more words:
That’s the prime benefit of a loan. Instead of dealing with 4-5 high-interest credit cards every month, you pay them off all at once with a lower-interest personal loan. You have to repay the loan, but you have just one payment a month, and it’s less than the combined bills you were stuck with.
A personal loan is another name for a debt consolidation loan, which is a proven way to escape credit card quagmires, so yes, this is a good idea if you struggling with credit card debt.
How to Pay Off Credit Cards with a Personal Loan
Getting a personal loan requires a little work, but it will be time well spent, and the process really isn’t that complicated.
- Ideally, you’ll have a rich uncle or aunt who’ll float you an interest-free loan. If you’re not that lucky, compare estimated interest rates on personal loans offered by banks, credit unions or online lending companies. Then start filling out the paperwork.
- Assuming you get the loan – and you probably will unless your credit score is totally in the dumpster – immediately start writing checks or transferring money to the credit card companies that have been holding you hostage to their exorbitant interest rates.
- Remember, that credit card debt hasn’t magically disappeared. You’ll still have to pay that amount (with less interest), but it will be a single monthly payment.
- Avoid backsliding. You don’t have to cut up your credit cards. Just don’t use them unless you can’t afford the purchase.
Pros of Using a Personal Loan for Credit Card Debt
A personal loan has drawbacks that have to be weighed, but the benefits can be pretty hefty. The main three, which we’ll expand on, are:
- Simplified payments
- Lower interest rates
- Improved credit score
The worst thing about debt is the debt itself. The second worst might be staring at a stack of credit card bills every month, opening each one, wincing at the amount you owe, then writing a check to each one.
Credit card consolidation makes things far less torturous. You write one check or make one bank transfer to one source every month.
Lower Interest Rates
The interest rate you pay depends largely on your credit score, but the average credit card interest rate was 19.4% in 2022.
The average personal loan interest rate was 10.16%, according to the St. Louis Federal Reserve Bank. That was one of the largest gaps in the St. Louis Fed’s 108-year history.
What would that mean in real-world terms?
If you got a $5,000 personal loan over three years to eliminate credit card debt, you’d pay $161.71 a month. The total interest you’d get socked for would be $821.
If you paid the credit-card rates for three years, your monthly payment would be $185, and you’d pay $1,510 in interest, almost twice the interest paid on a personal loan.
Improved Credit Score
Getting a personal loan improves your credit mix, which comprises 10% of your credit score. It shows creditors you can handle different types of debt.
It also lowers your credit utilization, which is the ratio of how much credit you’re using vs. how much you are approved for. If you pay off your credit cards, that utilization will go to an unbeatable 0%. Anything below 30% is excellent utilization and will improve your credit score.
Cons of Using a Personal Loan for Credit Card Debt
Now that you have an idea of the benefits of a personal loan you need to weigh, what are the main drawbacks you need to put on the scale?
- You’re still in debt
- Lower interest rates are not guaranteed
- Additional fees
You’re Still in Debt
There’s a rush of relief when you see a credit card balance of $0, but it’s a sugar high. A personal loan is a debt transfer, not a debt eliminator.
You must repay the loan, and the payments must be on time to avoid damaging your credit score. And to really avoid debt, do not let that initial rush of debt relief lure you into carelessly pulling out credit cards again. The longer those balances stay at $0, the better off you will be.
Lower Interest Rates Are Not Guaranteed
Though there’s a 6% difference between average credit card and personal loan interest rates, that gap can disappear if you have a rough credit history. You could even find the interest rate for a personal loan is higher than what you’re paying Visa or Discover.
Lenders consider your loan amount and term length, but the biggest factor in deciding your interest rate is your credit score. But don’t get easily discouraged.
You can still get a personal loan with bad credit. Lenders make money by lending, and most are eager to work with prospective customers to make the loan happen.
The loan amount you seek will be less than what you’ll actually pay. You have to factor in application fees, origination fees, late fees, prepayment penalties, returned payment fees, payment protection insurance and other semi-hidden costs. They may not all apply to your loan, but some will.
Alternatives to Personal Loans and Credit Card Debt
A personal loan has a lot of plusses, but as you can see, it might not be the ideal way to escape the credit card jail.
Everybody’s financial situation is unique, and yours might be better served by using a different approach. Here are some worth considering:
- Nonprofit Credit Counseling: Nonprofit credit counseling agencies off free credit counseling that will discuss the pros and cons of every solution available. And the counseling is FREE!
- Debt management programs: Offered by nonprofit credit counseling agencies who work with your card company to lower interest to 8% (sometimes less) and find an affordable monthly payment. It usually takes 3-5 years to eliminate debt.
- Balance Transfer Credit Cards: If you have a good enough credit score (above 670) you could qualify to transfer your balance to a new card with a 0% interest rate. The 0% is an introductory offer that usually expires in 6-18 months.
- Debt Settlement: This is an attempt to settle the debt by paying less than what is owed. There are many negatives with this, including having your balance grow because of late fees and interest and your credit score suffer as much as 100 points.
- 401(k) Loan: The good news is you’re borrowing from yourself. The bad news is your crippling your retirement fund. Be careful with this choice.
- Home Equity Loan or Home Equity Line of Credit: A very good choice if you have equity in your home, and maybe the lowest interest rate available for borrowing.
- Debt Avalanche: Single out the card with the highest interest rate and pay as much as you can afford on it, while simultaneously making minimum payments on other cards.
- Negotiating a lower Interest Rate: This should be the starting point, if you’re in trouble. Call your card company, explain the situation and ask for a lower interest payment. They want to keep you as a customer and should work with you to find an answer.
Living without a Credit Card.
Americans lived without credit cards before the 1950s. Here we are 70 years later and 80% of U.S. adults have at least one card. It might sound mind-boggling, but you can live without plastic. You just need the discipline to spend less than you make, which is what you should be doing in the first place.
The strategy is simple: Create a budget and stick to it.
It may sound tough but keep your eye on the prizes. Your credit score will improve, which means it will be easier to get a mortgage and take out other loans. You will develop the discipline to save money for things like vacations.
Oddly enough, you shouldn’t close your credit card account if it’s in good standing. Part of your credit score is your credit utilization ratio. Keeping a card with no charges on it will be beneficial in that area.
Just don’t give into the temptation to actually use it, or you might end up back in the hole you dug yourself out of.
Work With a Nonprofit Credit Counselor to Ease Your Debt
There’s no sense sugarcoating it, getting out of credit card can be a challenge. Getting a personal loan is a good way out, but you might need more advice, more education or more motivation.
Nonprofit credit counseling agencies are set up to handle those things. Certified counselors can help you come up with a budget and discuss your best options.
It might be through a debt management program or some other strategy, including the personal loan. Whatever the choice, it’s often easier to get out of a financial hole when you have help digging.
About The Author
Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].
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