What Are the Pros and Cons of a Personal Loan to Pay Off Credit Cards?
You have many debt repayment options. Is a personal loan a good option for you?
Contributing Writer at Tally
September 6, 2022
Credit card debt can sneak up on you and suddenly lead to basically throwing away cash by paying high interest rates.
If you’re struggling with credit card debt, you’ve likely researched options and found you may be able to secure a personal loan to pay off your credit cards. This is called a debt consolidation loan.
While debt consolidation loans can help you pay off debt and save on interest, they aren’t always the best option. To help you understand the risks and rewards, we’ll outline the pros and cons of a personal loan to pay off credit card debt. But first, let’s cover how debt consolidation loans work.
How debt consolidation loans work
Debt consolidation loans work much like any other loan — you submit an application and the lender decides if you’re approved based on your credit report. Many debt consolidation lenders require a minimum credit score in the 560 to 620 range for approval, but they’ll consider other credit factors like debt-to-income (DTI) ratio and credit utilization.
When the lender approves a personal loan to consolidate your high-interest credit card debt, it sends the loan proceeds to your bank account or to the credit card issuers you wish to pay off. Some lenders even allow you to split the proceeds, putting some in your bank account and sending part to your creditors. Each lender has its own policies.
Once you’ve paid off your credit cards with the consolidation loan, you’ll make one monthly payment to the loan issuer for the entire loan term. Debt consolidation loans are generally fixed-rate and fixed-term loans with a set monthly payment. With a 60-month, 9% APR loan on a $7,250 balance, you’d pay around $150 each month, but over $9,000 in total.
Some debt consolidation loans have variable interest rates, meaning the interest rate can change throughout the term. This changing rate can result in fluctuating monthly payments. When you’ve satisfied the loan balance, you are officially debt-free.
Pros and cons of a personal loan to pay off credit card debt
Is a personal loan a good idea for consolidating your high-interest credit card debt? Let’s explore the pros and cons of a personal loan to pay off credit card debt to find out.
Pros of a personal loan to pay off credit card debt
Personal loans offer some benefits when you use them to pay off credit card debt. Here are the pros of using a personal loan to consolidate credit card debt.
A lower interest rate is possible
The average credit card interest rate is 16.45%. That can add up to huge monthly interest charges if you carry a relatively high balance. However, as of May 2022, a commercial bank's average two-year personal loan had an 8.73% interest rate.
That’s about half the interest you’d pay on your credit cards. So, if you had a $10,000 balance on credit cards with 16.45% interest, you’d pay roughly $137 per month in interest alone.
With an 8.73% interest rate on a two-year $10,000 personal loan, you’d pay only $72.75 in interest the first month. Plus, the interest you pay monthly decreases with each payment. You’d pay only $934.63 in interest for the loan term.
You’ll have fewer monthly payments
When you have multiple credit cards with balances, you have multiple monthly payments to manage. It can be easy to forget one of them and end up with a late fee or even a late payment mark on your credit report, which can negatively impact your credit score.
A debt consolidation loan pays off all those credit cards with one personal loan. This leaves you with only one monthly payment, making it easier to manage.
Credit utilization ratio may be reduced
Your credit utilization ratio — your total credit card debt relative to your total credit card limits — is part of the factor in the FICO scoring algorithm, and comprises 30% of your FICO credit score. The higher your credit utilization ratio is, the more negatively it affects this factor, which can lower your credit score.
Paying off your credit cards with a personal loan can dramatically reduce your credit utilization ratio and potentially improve your credit score.
Cons of a personal loan to pay off credit card debt
Personal loans are beneficial when you use them to pay off credit cards. However, you should also consider the cons of a debt consolidation loan.
You’re not guaranteed a low interest rate
While a debt consolidation loan generally has a lower interest rate than credit cards, there’s no guarantee. The interest rate on a personal loan to consolidate credit card debt can range from 7% to 36%, depending on your credit history and the lender.
A higher interest rate can lead to paying off only high-interest-rate cards with the loan and leaving other credit card balances as they are. Ultimately, this negates one of the pros of a personal loan: having only one monthly payment.
Loan amount may not suffice
You might not get a large enough loan offer to pay off your credit card debt. This can leave you with the personal loan, plus all the remaining credit card payments. Again, this negates the pro of having only one monthly payment.
Monthly payment may be unaffordable
If you’re barely making minimum payments on your credit card, you may struggle to make the loan payment too. Because a debt consolidation loan is a fixed repayment term installment loan, monthly payments are generally higher than the minimums due on credit card payments.
This could strain your monthly budget and cause you to struggle to pay other bills.
Personal loans may have fees
Like other loans, many personal loans come with fees. These can include origination fees, application fees, annual fees, payment processing fees, prepayment penalties and more. Over time, these fees can add up and negate the interest savings you expect.
You may be tempted to take on more debt
When you pay off debt on your credit cards with a personal loan, you suddenly have access to your full credit limit on these credit cards. This might tempt you to use the cards again, putting you right back into credit card debt on top of the debt consolidation loan.
There may be a short-term credit score decrease
When you apply for a personal loan to consolidate credit card debt, lenders will typically run a hard credit inquiry to determine if you’re eligible. This hard credit pull will show on your credit report and can reduce your credit score by up to five points.
Also, adding a new loan to your credit report will shorten your length of credit history, which makes up 15% of your credit score. This can also result in a small, short-term credit score decrease.
Better options may be available
A debt consolidation is just one type of loan to help you manage debt. Other loan and non-loan options available may be better suited for your financial situation. These alternatives may include:
Personal loans aren’t a great option for paying off credit cards
After reviewing the pros and cons of a personal loan to pay off credit card debt, it’s clear the cons outweigh the pros. You risk getting a loan with a higher interest rate than what’s on your credit cards, an insufficient loan amount or even an unaffordable monthly payment. Plus, you could run into excessive loan fees or be tempted to use your paid-off credit cards.
Before opting for a debt consolidation loan, review options to help you pay off credit card debt. One such option is the Tally†credit card debt repayment app. This app helps you manage your credit card payments, and Tally offers a lower-interest personal line of credit, allowing you to efficiently pay off higher-interest credit cards.
†To 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% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.