Personal Loan To Pay Off Credit Card Debt: Good Or Bad Idea?
Personal Loan To Pay Off Credit Card Debt: Good Or Bad Idea?
Credit card debt
As the American public has experienced first hand, credit cards are a double-edged sword. If you have the knowledge, income, and discipline to use them wisely, they can be one of the best tools in your financial arsenal. If you’re missing any of these ingredients, though, you can quickly get buried under payments that you can barely afford. The recent financial legislation only curbs the abuses that customers were subjected to by credit card companies, but it doesn’t help much when it comes to actually getting out of credit card debt. And that’s what most people ultimately want to achieve. So how can it be done?
Well one of the ways is to get a personal loan to pay off all those credit card balances.
How the process works
In theory, it’s very simple. You get approved for the loan, and you use the proceeds to pay off all your credit cards. So in the end, you only have one loan, with one interest rate, and one due date. You no longer have to keep track of several payments, and terms and conditions. Instead, you just need to handle that one loan payment. Another benefit is that while credit card debt is revolving by design, a personal loan has a set duration: at that point, the loan should be paid off.
So you get a, say, 4 year personal loan, pay off your credit card debt, and in four years you should have paid off that loan and be in a much better financial situation, right? Actually, it depends on a handful of factors, namely, the type of personal loan, the interest rate it carries, and what happens after you get the loan and pay off the cards.
Type of personal loan
Your credit score is going to play a big role in whether or not you even qualify for a personal loan. See, a personal loan is unsecured debt (it’s not backed by collateral) and unless you have good credit, most financial institutions won’t approve you for one. You can go with a secured loan if you have the money, but honestly, it might be better to just use that money to lower your balance. That is, unless what you need most is the structured payments that come with the loan.
If you own a house, you might be considering a home equity loan. This is not a bad idea in and of itself, but you just need to be aware that your credit card debt is (typically) unsecured. There’s no asset that the creditor holds as collateral (unlike in the case of a mortgage or a car loan). When you get a home equity loan to pay off credit card debt, you substitute that unsecured debt with debt that’s backed by your house. Something to think about.
Interest rates
This also ties into the credit score situation. Without a good credit score, even if you do manage to get an unsecured personal loan, it will probably be at high interest rates that will fail to generate any substantial savings from what you were paying initially. That is unless you can get a home equity loan, where the rates are usually competitive (but remember the caveat).
But just like in the previous point, there could be positives to it even if you don’t save a lot of money per se. We’ve mentioned them before: managing your debt becomes easier, and you have a fixed date at which it will be paid off.
What happens after paying off the credit cards
This might be the biggest, most important factor. It doesn’t matter how good a deal you get on that personal loan, and how disciplined you can be when you’re paying it off, if you can’t keep from charging those cards all over again, it will all be for naught. In fact, this is what happens to a lot of people who get a loan to pay off their credit cards. They get the loan, pay off their credit cards, and then slowly but surely, they swipe until their balances get right back to where it was before the loan. Now they have to pay for the loan AND the credit cards.
Verdict
In the end, what matters the most is your discipline. Discipline to make your loan payments until you’ve paid it off, and discipline to avoid racking up your credit card balance right back to where it was before. If you can do both, and can qualify for a loan, then it can be advantageous. Otherwise, seek other options such as paying more than the minimum balance, asking to be considered for a hardship program, or transferring your balance to a card with lower interest rates.