By Karen Lynch | American Express Credit Intel Freelance Contributor
5 Min Read | November 06, 2019 in Money
Personal loans to pay off credit card debt are fairly common; they lower interest rates on what’s owed.
It’s not simple: you may need to do the math to be sure of the real costs.
Any loan should be part of a personal finance plan that keeps you from spending yourself back into unmanageable debt.
“Borrowing from Peter to pay Paul” is as old as the Middle Ages and as modern as taking out a personal loan to pay off credit card debt. Borrowing to cover credit card debt has its pros, cons, potential pitfalls, and plentiful choices, including secured loans, unsecured loans, and balance transfers to new credit cards. But when you enter the land of Peter and Paul, it’s important you tread carefully to be sure you are not solving one money problem by creating another.
Eight in 10 U.S. adults have credit cards, and over half of them carry unpaid balances from month to month, according to analysis from the U.S. Federal Reserve.1 On average, the Fed says, these credit card “revolvers” pay over $700 a year in interest.2 In a consumer poll, over half of card holders carrying balances said they had been doing so for over a year.3
Paying hundreds or even thousands of dollars of credit card interest a year is not just a drain on your personal finances. Carrying a credit card balance can also lower your credit score, if your credit utilization ratio is too high. And a bad credit score, in turn, can drive up other costs—for your car loan, insurance, or cell phone.
You may even be managing multiple credit card balances. In this case, consolidating all your credit card debt under one loan could simplify your personal financial management and help you avoid late payments, interest charges, and the possible fees and interest rate increases associated with missing payments.
If your balance is high, a personal loan may be better for paying off credit card debt. Personal loans tend to carry a lower interest rate than credit cards, which can help make your payments more affordable. While there are no hard-and-fast rules, several factors will determine whether you should opt for a personal loan to pay off credit card debt—and which kind of loan.
One factor is how much debt you have to transfer. Lenders typically set a $1,000 to $5,000 minimum for personal loans.4 Another factor is your credit score, which could play a deciding role—from the interest you pay to whether you can even qualify for a loan. Some lenders set the minimum score as low as 525, but others require a higher credit rating.5 Your debt-to-income ratio will also be examined.
Secured loans—usually home equity loans—are normally easier to get, with lower interest rates and higher borrowing limits than unsecured loans. Using your home as collateral lowers the risk to the lender but raises yours—you could lose the roof over your head if you default.6 Approvals for unsecured loans, the more common type of loan for paying off credit card debt, are based on available financial data and credit scoring.
Whether secured or unsecured, personal loans are generally paid in monthly installments over a fixed period that ranges from one to five years. You might use a debt repayment calculator to figure out how much you will actually pay on the loan. Yes, the interest rate may be lower, which will help you in the near term. And, it may be set at a fixed rate versus many credit cards’ variable rates, making your monthly bills more predictable. Over the life of a longer-term loan, however, you could actually end up paying more than expected.7 Also be sure to note any application, origination, prepayment, and late fees.
The good news is that, unlike revolving credit card debt, carrying a personal installment loan does not tend to hurt your credit rating. It might even bump up your credit score, if you pay on time.8
Online lending marketplaces provide plenty of comparisons and reviews of personal loans. One analysis has estimated their average interest rates to run at least 4 percent lower than average credit card rates.9 (Though if your credit score is low, the difference could be erased.)
While banks, credit unions, and other traditional financial services companies dominated the market for personal lending in 2010, market research has shown that fintech lenders commanded a 30 percent share by 2019.10 Analyzing the largest FinTech in the personal lending market in 2019, the Fed reported that, “Some consumers have saved a significant amount by borrowing … to pay off their credit card balance and boost their credit scores.”11
Instead of opting for a loan to pay off their cards, some consumers consider balance transfers to new credit cards, especially for smaller amounts of debt. A balance transfer fee in the single digits might be required, but some card companies waive that fee to attract business. Card companies may also offer a 0 percent introductory APR for at least 6 months, and 15 months is not uncommon, but you need to be sure the offer applies to balance transfers as well as purchases. Examine any no-interest balance transfer offer with care to avoid mistakes, some of which could affect your credit score.
Planning, budgeting, and economizing could improve your chances of success in paying down any debt. You should consider plotting exactly what amount you will pay every month on your new loan or balance transfer card, and how you will find the money. Otherwise, late fees and increased interest rates could set you back again.
Think about how you got into this situation in the first place. If non-essential spending is the culprit, financial advisors say to identify those items and trim spending. Otherwise, new debt could begin to balloon the moment you take out a loan to pay off your old debt.
While you can take out a loan to pay off credit card debt, it’s not a simple choice. You’ll want to analyze a multitude of options from many financial services companies, because which option works best for you will depend on several factors. Whether you’re considering a secured or unsecured personal loan or transferring your balance to another card, fees and interest rates can come as a surprise. Finally, you’ll likely need a plan in order to succeed.
1 “Credit Card Utilization and Consumption over the Life Cycle and Business Cycle,” Federal Reserve Bank of Boston
2 “Credit Card Debt and Consumer Payment Choice,” Federal Reserve Bank of Boston
4 “Should You Take Out a Loan to Pay Off Credit Card Debt?,” Credit Karma
5 “How Personal Loans Work and Common Traps to Avoid,” Magnify Money
6 “Secured Loan vs. Unsecured Loan,” American Consumer Credit Counseling
7 “Should I Get a Personal Loan to Pay Off my Credit Card?”, Experian
9 “2019 Personal Loans Industry Study,” SuperMoney
11 “Consumer Lending Efficiency: Commercial Banks Versus a FinTech Lender,” Federal Reserve Bank of Philadelphia