Using a personal loan to pay off credit card debt

What is the difference between a personal loan and a credit card?

Personal loans and credit cards are both forms of borrowing from a lender, but they work differently.

Lenders give personal loans to approved borrowers for a set amount of money at a fixed interest rate over a fixed term. You get the money in a lump sum and start repaying a personal loan immediately, and the monthly payment is the same for each billing cycle. You can’t add debt to your personal loan; if you need more funds, you must take out a new loan.

A credit card is a revolving line of credit. The credit card company sets a credit limit on your card based on your creditworthiness, and you can borrow up to this limit. Once you repay credit card charges, that credit is available to use again. Credit cards have variable annual percentage rates (APRs) and require only a minimum payment each month.

However, if you only make the minimum payment, you incur interest that adds to your balance, making the debt harder to pay off. This is why many people feel like they’re in a never-ending debt cycle. If you’re struggling to pay off debt, switching your variable-rate credit card debt to a fixed-term personal loan could help.

Benefits of using a personal loan to pay down credit card debt

There are many perks to rolling your credit card debts into one personal loan, especially if you can secure a lower interest rate than your credit card APR. Paying off debt with a lower interest rate can save you a lot of money monthly and on the life of the debt.

Many consumers find juggling multiple debts and bills overwhelming, and a personal loan can solve this problem. With a fixed-rate loan, you will know exactly how much you owe each month, how long you will be paying your loan and how much total interest you will pay. This method can help you pay off your debt faster, since there is a set end date. Credit cards are a revolving line of credit with a variable APR, making it hard to know when you will pay off your card in full.

Using a personal loan to repay credit card debt can also significantly increase your credit score, as long as you aren’t adding to your credit card debt while paying off your loan. Your FICO credit score is made up of five categories:

• Payment history
• Amounts owed
• Length of credit history
• New credit
• Credit mix

Payment history and amounts owed, which includes credit utilization ratio, together make up 65% of your credit score. Using a personal loan to repay your credit cards can improve both of these categories if you make on-time loan payments each month and lower your credit card balances (which reduces your credit utilization ratio).

Pitfalls of using a personal loan to pay down credit card debt

While consolidating credit card debt with a personal loan is a good choice for many, it isn’t a one-size-fits-all solution.

“A personal loan may not be the answer if you’re not confronting the real issue,” said Barry Rafferty, chief information officer at the digital finance company Achieve. “If you’re looking to a loan to help because you’re not living within your means, it’s just a temporary fix. Be sure to understand the place a personal loan would have in your overall finances — now and [in the] future.”

Your creditworthiness also determines whether a personal loan is a good option for you. If you have a low credit score or low income, a lender might give you a higher interest rate, making your debt load even costlier.

Additionally, if you can’t afford to make the loan’s monthly payments, getting one is not the right choice. With credit cards, the minimum monthly payment is usually easier to swing on a tight budget.

“If you’re in significant debt, having a hard time making even minimum payments and perhaps have endured some type of financial hardship [such as] job loss, divorce or major medical expense, a personal loan probably is not the best answer,” Rafferty said.

In these cases, consider other options for debt consolidation (more on those in a moment).

How to pay off credit cards with a personal loan

Many lenders offer a loan quote without any effect on your credit score. Getting quotes from multiple lenders will help you determine if you can afford the monthly loan payments and what rate range you qualify for.

If your credit score is keeping you from the best rates, consider taking two to three months to work on that first. Make on-time payments and pay down as much credit card debt as possible.

Once you decide which lender and repayment length is best for you, the loan application is fairly simple. Most lenders will want to see:

• Proof of identity
• Proof of income
• Proof of address
• Bank information or creditor information (if the lender is paying the creditor directly)
• What you plan to use the loan for

Lenders perform a hard pull on your credit during the official application process, which could temporarily decrease your credit score.

Most lenders with online applications approve qualified applicants within one to three days. If you’re not approved, you will receive information stating why.

Once your application is approved, you’ll receive the final loan terms and ate. At this point, you can change your mind about the loan without any consequences — apart from the ding on your credit score. If you agree to the terms, you’ll receive the funds within one to three days, or the lender will pay off the designated creditor(s) directly.

Alternatives to using a personal loan for credit card debt

If you want to tackle your credit card debt, using a personal loan for consolidation isn’t the only option. You can also consider the following strategies:

Bottom line

A personal loan can be a good way to tackle credit card debt once and for all. However, it isn't the perfect solution for people who can’t qualify for low interest rates or aren’t willing to adjust their budgets to avoid future debt.