When tackling your debt, the idea of taking on an additional loan may seem counter intuitive and unconventional. However, there are some instances when this strategy can actually help you eliminate debt faster.
Personal loans are unsecured loans available to consumers who need extra money. This could be to pay for a vacation, a wedding, moving expenses, debt consolidation, or a variety of other personal reasons. Unsecured loans are not backed by assets or collateral, so they can carry higher interest rates than vehicle or mortgage loans. These loans are typically offered for smaller amounts and borrowers with good credit are more likely to qualify and will receive lower interest rates.
Taking out a personal loan to pay off your credit cards is not for every person and every debt situation. Read on and ask your financial advisor these important questions to see if this option might work for you.
Will I pay less in interest?
You are not eliminating your debt by taking out a personal loan to pay off your credit card balances. You are simply moving the debt from one (or more) lender to another. So, paying less in interest is the major benefit to this strategy. If your personal loan is offered at a higher interest rate than your current credit card, then it probably doesn’t make sense to move the debt.
Can I consolidate multiple payments into one?
Keeping track of multiple credit card payments with indefinite payoff timelines can be overwhelming. Consolidating these debts into one loan may relieve stress by allowing you to make one payment per month. And with a personal loan that is broken into monthly installment payments, you’ll know exactly when the balance will be paid in full.
Will my monthly payment be less?
In some situations, using a personal loan to pay off several credit card debts can result in a lower monthly payment. This will allow you to put the additional money directly toward the principal on your personal loan and pay it off more quickly.
For example, if your combined monthly credit card payments totaled $400 and your new loan payment is $325 a month, you can apply the remaining $75 directly to the principal balance on the loan. If you take out a personal loan in the amount of $4,000 with a 12-month term at 8% interest, the extra $75 would result in paying off the loan in 10 months and would save you approximately $25 in interest.
If your monthly payment on the loan is NOT less than what you are currently paying each month on your credit cards, make sure that you will pay less over the life of the loan than you would paying individually on each credit card. Run the numbers.
Will I have to pay any fees?In some cases you may be charged an origination fee by the lender for processing your loan application and paperwork. This is typically a small percentage of the overall loan. Also, some lenders charge a penalty for early payoffs which is not ideal if your goal is to pay off the loan as quickly as possible.
Using a personal loan to pay off credit card debt is not the best option for everyone, so do your homework in advance. Keep in mind that if you do take out a personal loan and fail to make your payments, your credit score will take a hit, and your ability to qualify for loans in the future may be effected. However, if you are currently making payments on multiple credit cards with high interest rates and no end in sight, consider a personal loan to provide more structure to your debt payments and decrease the overall interest you’ll pay.