Should You Get a Personal Loan to Pay Off Credit Card Debt?
In some cases, paying off one debt with another debt can be a helpful strategy that saves money.
Contributing Writer at Tally
July 29, 2021
Credit cards can be helpful with their reward points, ability to avoid interest charges and other perks. However, they can also be the source of financial struggles when the account balance starts to increase.
Fortunately, there are plenty of tools available that can help you control your credit card debt and return to a more stable financial footing. One such strategy is using a personal loan to pay off credit card debt.
While it might not be for everyone, using a personal loan to pay off credit card debt may be a great solution for some. Below, you'll learn the pros and cons of using a personal loan to pay off credit card debt, how to get a loan and use it and a few alternatives to personal loans.
Benefits of using a personal loan to pay off credit card debt
Using a personal loan to pay off debts — also known as debt consolidation — has a handful of distinct benefits, ranging from lowering the total cost of repayment to potentially increasing your credit score.
Here are the key benefits of using a personal loan to pay off credit card debt.
One monthly payment
If you have multiple credit card payments per month, it can be difficult to keep up with them, resulting in late fees or, even worse, late payment marks on your credit report.
By consolidating multiple credit cards with a single personal loan, you'll have just one payment each month. This can make paying your monthly bills significantly easier, reducing the potential of forgetting to make your payment on time.
Lower interest rate
Debt consolidation loans generally have an interest rate or annual percentage rate (APR) in the 11.8% to 23.4% range for someone with fair or better credit. The average credit card has an interest rate of 14.61% to 24.14%, depending on your credit. Some credit cards can even reach 29% APR or higher.
The lower interest rate of a debt consolidation loan can help you save big on interest charges while paying off your debt.
For example, if you have a credit card with a $5,000 balance at 14.61% interest and want to pay it off in three years, you'd pay $2,074 in interest charges. If you paid off that card with a five-year personal loan at 11.8%, you'd pay only $1,643.05 in interest charges. That's nearly $400 in savings.
With credit card's minimum payments often designed to extend your time in debt, it can be challenging to calculate exactly when you'll pay it off. With the fixed terms a personal loan offers, you'll know exactly when you'll be debt-free while making only the minimum payments.
You’ll usually get a fixed interest rate with personal loans, whereas many credit cards have a variable interest rate. This fixed rate means your APR will remain the same throughout the repayment process, helping add consistency to your debt-repayment plan.
Lower credit utilization ratio
Your credit utilization ratio — your credit card balances relative to your credit limits — can significantly impact your FICO credit score. If you creep over the 30% credit utilization mark, you may start seeing your score decrease.
By paying off these credit card debts with a personal loan, you're reducing your credit utilization ratio, which may result in a credit score increase.
Improved credit mix
Your credit mix — your variety of credit types — makes up 10% of your FICO credit score. This variable looks at your mixture of revolving debt, such as credit cards, relative to your installment loans, such as auto and personal loans. With a balance of different debt types, your credit score may increase.
If revolving credit card accounts dominate your credit report, adding a personal loan for credit card consolidation may help balance the mix and increase your score.
Drawbacks of using a personal loan to pay off credit card debt
There are plenty of benefits to using a personal loan to consolidate debt, but there are a few potential pitfalls.
Here are some downsides to a personal loan you may want to consider.
Many times, personal loans come with various fees, such as an origination fee. Depending on the loan terms and loan amount, these fees can get rather high. Under certain instances, the fees can make the total loan cost higher than the interest charges on your credit card, negating the cost savings you were hoping for from the personal loan.
Higher monthly payments
In some cases, the only way to get a great interest rate on a personal loan is to shorten the repayment term. Even with a lower interest rate, shortening the repayment term will almost always result in a significantly higher monthly payment.
If the monthly payment gets too high, your monthly budget may not be able to cover it, making a personal loan impossible without increasing your income.
Getting approved for the best debt consolidation loans generally requires at least a good credit score, which FICO says is a 670 or higher. With fair credit or bad credit, you may not be able to get approved for a personal loan or may get approved for one with less favorable terms.
Approval goes beyond your credit score too. When applying for a personal loan, lenders will also look at your credit report to determine your credit utilization and at your income to determine your debt-to-income (DTI) ratio.
If either your DTI or credit utilization is outside the lender's requirements, you likely won't get approved, even if you plan to pay off all or some of the debts the lender used to calculate these requirements with the personal loan.
Immediate credit score hits
When applying for a personal loan, most lenders will make a hard credit inquiry. This will show up on your credit report and could reduce your score. FICO only considers credit inquiries for the last 12 months when calculating your credit score, so the impact is short-term.
Also, adding a new loan to your credit report can negatively impact your “length of credit history” factor, which makes up 15% of your FICO credit score. However, the credit score increases from the better credit mix and reduced credit utilization ratio could offset this quickly.
How to use a personal loan to pay off credit card debt
If you've decided a personal loan is the right path to becoming debt-free, it's time to take the steps toward finding the right loan and paying off those debts. Here are some steps to get started.
1. Organizing your credit card debt
Organize all your credit card debts and add them up to determine what debts you'd like to pay off and what loan amount you'll need to accomplish this.
2. Shopping for the best loan terms
Begin applying for personal loans to find which lender can offer you the best terms for your financial situation. You can find many lenders online, but you may also want to explore the financial institution where you have your bank account or a credit union.
Keep in mind that while you're shopping for the right personal loan rates, each hard credit inquiry won't further lower your score. FICO allows for rate shopping — applying for multiple loans to check their terms — within a set period without dropping your score. The rate-shopping window varies by lender, but it's typically 14 to 45 days.
3. Choosing the best loan option for you
After collecting a range of loan offers, choose the offer that best fits your personal finance goals. Remember, this isn't always the one with the lowest interest rate or monthly payment. You may also want to consider loan costs and other benefits, like a lower interest rate for enrolling in autopay.
4. Using the personal loan to pay off your credit card debts
After accepting a loan, the lender will likely deposit the loan directly into your bank account the next business day, and you can use the cash to pay off your credit card balances. If the loan isn't enough to pay off all your credit card debts, it’s best to pay off the ones with the highest interest rates first.
Some personal loan lenders may also offer to repay the credit card companies directly. In exchange for this direct repayment, the lender may offer a small APR discount. This is a great way to eliminate the guesswork and save money simultaneously.
5. Immediately repaying any remaining loan amount
If you miscalculated your debts or the lender would only offer a loan amount greater than the credit card debt you owed, you may have some of the loan amount leftover in your bank account. Instead of keeping this money and paying interest on it, immediately make a loan payment equal to the excess amount.
This will lower your principal balance and accelerate your repayment.
Personal loan alternatives
A personal loan won’t be the right fit for everyone. Here are a few personal loan alternatives to check out.
Personal line of credit
A personal line of credit is similar to a personal loan, but the key difference is it's a revolving credit line you can use more than once to repay several credit card debts.
The Tally1 credit card repayment app includes an option for a low-interest personal line of credit. This line of credit may offer a lower interest rate than most credit cards and you can use it repeatedly to repay multiple credit cards. On top of that, you make just a single payment to Tally, and it'll disburse the funds to all your credit cards using the debt avalanche method.
Balance transfer credit card
Credit cards often offer 0% APR deals for a fixed period, typically six to 18 months, for transferring a balance from one credit card to another. If you have a relatively low credit card balance, you can transfer it to a no-interest credit card and repay your credit cards interest-free for a specified period.
Watch out for those balance transfer fees, though. These generally range from 3% to 5% of the balance you're transferring. So, if you transfer $2,000, you may pay $60 to $100, depending on the fee. These balance transfer fees are generally far less than paying interest charges, but you may want to confirm this before transferring.
A personal loan to pay off credit card debt can save you big
If you've grown tired of high-interest credit card debt and are looking to get it under control, a personal loan may be a great option for you. Not only will it save you on interest charges, but it may also streamline your monthly payments, give you a fixed payoff date and even improve your credit score.
Sure, there are a few tradeoffs, but the money you can save and the peace of mind of having a clear debt-free date may be enough to overcome those.
If a personal loan isn't right for you, there are alternatives out there. Consider Tally, a low-interest line of credit that can help qualifying users pay down your higher-interest credit card debt.
1To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) Will be between 7.90% - 29.99% per year, and will be based on your credit history. The APR will vary with the market based on the Prime Rate.