Using a Personal Loan to Pay Off Credit Card Debt

Personal loans vs. credit cards: how they work

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 by consolidating your debt into one consistent payment.

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. Here’s how the process of researching and applying for a personal loan works:

1. Improve your credit score: 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.
2. Research and apply for loans: 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
3. Undergo a credit check: Lenders perform a hard pull on your credit during the official application process, which could temporarily decrease your credit score.
4. Wait for approval: Most lenders with online applications approve qualified applicants within one to three days. If you’re not approved, you will receive information stating why.
5. Get your loan terms: Once your application is approved, you’ll receive the final loan terms and rate. At this point, you can change your mind about the loan without any consequences (apart from the ding on your credit score).
6. Get your funds and pay your debt: If you agree to the terms, you’ll receive the funds within one to three days, and you can use them to pay off your balance(s) in full. Alternatively, the lender will pay off the designated creditor(s) directly.

How to compare personal loan offers and calculate savings

Before you accept a personal loan to wipe out your credit card balances, compare a few offers side by side.

Run the numbers for each offer you’re considering; the right loan should reduce both your monthly payment stress and your long-term interest costs.

1. Start with the APR, since it includes both the interest rate and required finance charges. A lower APR typically translates to lower total borrowing costs.
2. Next, look at fees — especially origination fees — because they reduce the amount you receive and can change the true cost of the loan.
3. Then review the repayment term, the monthly payment and whether the lender offers direct payment to creditors.

To understand your potential savings, compare the loan’s projected interest costs to what you’d pay if you kept your current credit cards. You can do this with a basic loan calculator or an online debt-consolidation calculator.

For example, if you owe $8,000 on credit cards at 26% APR and replace it with a three-year personal loan at 14% APR, you could save hundreds in interest while locking in a predictable payoff date.

How loan term length affects total interest paid

Your loan term plays a big role in how much your consolidation loan ultimately costs. Shorter terms, such as two or three years, usually come with lower interest rates and significantly less total interest paid, but they also mean higher monthly payments.

Longer terms stretch payments out to five, six or even seven years. While this can make the monthly bill easier to manage, you’ll typically pay a higher rate and accumulate more interest over time.

Even with a favorable APR, extending your term adds cost. For instance, a $10,000 loan at 12% APR costs about $1,900 in interest over three years but more than $3,600 over seven years.

As you compare terms, also check for fees like late fees, origination fees and any charges for paying creditors directly. Choosing the shortest term you can comfortably afford helps keep your total interest low while still giving you predictable payments and a clear end date to your debt.

How does using a personal loan for debt payoff affect your credit score?

While taking out a personal loan to pay off credit card debt might lower your score initially, you’ll likely see a score boost in the long term.

Your FICO credit score is made up of five categories:

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

In the short term, taking out a personal loan will negatively affect your credit score. That’s because lenders do a “hard” credit check, which can temporarily lower your score by up to 10 points. Opening a new account will also decrease your score by lowering your average account age.

However, this method can increase your score over time. Payment history and amounts owed, which includes your 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). It also increases your credit mix.

» READ MORE: What is a credit utilization ratio?

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.

• Predictability: 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.
• Faster payoff: This method can also 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.
• Credit score increase: 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.

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

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.

“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,” he said.

Here are some scenarios in which a personal loan to pay off credit cards isn’t a good idea:

• Poor creditworthiness: 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.
• Tight budget: 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.
• Drowning in debt: “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.

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:

Pay off debt yourself

“The best way to pay off credit card debt is to do so on your own, with the help of a good budget and the avalanche or snowball method,” said Rafferty.

These debt repayment strategies involve paying extra toward one debt to see some quick wins. In the avalanche method, you put money toward high-interest debts first to save more in the long run. In the snowball method, you pay off low-balance debts first to gain momentum.

Pull from your home equity

If you’re a homeowner, you could consider drawing funds from your home equity. “Depending on an individual’s situation, a home equity loan or home equity line of credit could possibly still offer lower interest rates than a personal loan if you have enough equity in your house to qualify and very good credit,” Rafferty said.

“Still, since a home equity loan and line of credit both use the home as collateral, there is inherent risk with these options,” he warned.

Do a 0% APR balance transfer

Finally, if your credit score is high enough to qualify for a 0% introductory rate credit card, you can transfer your debts to that card. These promotional interest rates typically last between six to 18 months. You’ll need to pay off the entire balance before the rate expires, or you’ll incur interest costs. Bear in mind there is often a balance transfer fee.

» COMPARE: Balance transfer or personal loans: What is best?