Are your credit card debts piling up like snow in a winter blizzard? If so, you may be looking for ways to pay them off and one option would be to take out a personal loan. The question is would this really make sense.
You’re not really paying off your debts
The biggest downside to getting a loan to pay off credit card debts is that you’re not really paying off your debts. What you’re doing is moving them from one set of creditors to a new one and restructuring them. But this could make sense depending on several factors.
- The terms
The first difference between credit card debt and a personal loan is that credit cards have no defined loan term. In fact, the credit card providers’ main objective is to keep you in debt forever. In comparison, a personal will have a defined term. They typically have four to five-year terms but could be longer.
Personal loans are like credit card debts in that they are both unsecured loans. In other words, you’re not required to put up collateral to get a credit card nor are you required to provide collateral – or security – in order to get a personal loan.
The interest rates
Fixed rate credit cards have an average interest rate of 13.81%. In the case of variable-rate credit cards, the average interest rate is 14.52%. If you have a good credit history, you should be able to get a personal loan with a much lower interest rate. In fact you might be able to borrow the money at 8% or less.
The monthly payments
If you have multiple credit card debts, you may have a monthly payment of $500 or higher. In comparison, a personal loan for the same amount of money could have a monthly payment of $250 or even lower.
The total interest cost
Because a personal loan will have a longer term than credit cards, you may pay more in interest over the life of the loan. As an example of this if you were to borrow $20,000 at 8% and your payment was roughly $500 a month, the loan would end up costing you $3,339.07.
Do the math
The best way to determine whether it would make sense to swap your credit card debts for a personal loan is to do the math. You would need to determine your loan payment and then compare it with the sum of the minimum monthly payments you’re currently making on your credit cards. If the sum of the credit card payments exceeds what the payment would be on a personal loan, then it might make sense to make the change
How this would affect your credit score
One factor you don’t want to lose track of when deciding about swapping credit card debt for a personal loan is what this would do to your credit score. Unfortunately, there are both pluses and minuses. On the plus side you’ll be increasing the types of credit you are using and at the same time increasing the available balances on your cards. This would have a favorable impact on your “credit utilization,” which accounts for 30% of your credit score. On the negative side, you’ll have generated a recent credit inquiry – related to applying for the loan. Also, you’ll need to be very careful so you don’t begin running up balances on your credit cards while making payments on that personal loan. And you won’t want to close any of those cards when they reach zero balances because this, too, would have a negative effect on your “credit utilization.”
Where to find a personal loan
You may find it hard to get a personal loan at any of your local banks. They’re just not very interested in providing personal loans these days because they require a fair amount of paperwork and, thanks to today’s low interest rates, don’t generate a lot of profits. However, you might be able to get a personal loan at a credit union. They may be more interested in providing you with a personal loan because they have no shareholders. Their members own them. Of course, you’ll have to find a credit union you could join. Some credit unions such as Navy Federal limit their membership to members of a certain class – in this case, the armed services. But there are others where just about anyone can join.
You could also go online and find potential lenders. For instance, Springleaf Financial offers personal loans from $1000-$25,000 and Creditloan has personal loans up to $5000. There is also a new breed of lenders called peer-to-peer lenders. These are websites such as the Lending Club and Prosper where the loans are made from one person or group of people to another with no financial institution involved. The Lending Club offers loans up to $35,000 and Prosper has loans up to $25,000. The interest you’ll pay on these loans will depend primarily on your credit score. If you have a good credit score, you might be able to qualify for an interest rate as low as 8%. On the other hand, if you have a very poor credit rate you could be charged as much as 29.99%.
Optional ways to pay off credit card debts
If for some reason the idea of getting a personal loan to pay off your credit card debts doesn’t appeal to you, you do have options. This includes.
1. Do a balance transfer – transfer your high interest credit card debts to a card with a lower interest rate or, even better, a 0% interest balance transfer card
2. Snowball your credit card debts – put them in order from the credit card that has the highest interest rate to the one with the lowest. Then focus on paying off the one with the highest interest rate while continuing to make the minimum payments on your other credit cards. When you get that first credit card paid off, you will then have more money available to begin paying off the card with the second highest interest rate and so on.
3. Create a credit card debt avalanche – this is roughly the same as snowballing your credit card debt except you put your debts in order from the one with the smallest balance to the one with the highest, You then do everything possible to pay off the one with the smallest balance then the one with the next smallest balance, etc.
4. Negotiate with your lenders – this is where you contact your creditors and offer` to settle your debts for less than what you owe. Spoiler alert – for this to be effective you will have to be nearly 6 months behind in your payments. And this would have a definitely negative affect on your credit score.
5, Earn more money – Get a second job and use all of the money you earn to pay off your debts. This is generally the fastest way to get out of debt.
6. Borrow from your retirement fund – if you have an IRA or 401(k), you could borrow from it and use the money to pay off your credit card debts. This can be a very good option because even though you will be required to pay the money back, you’re actually paying it to yourself.
7. Declare bankruptcy – this is often called the ultimate solution because it will get rid of or discharge almost all of your unsecured debts and probably within six months. Of course, it will leave a stain in your credit reports that will last up to 10 years.
Lastly, here’s a video with three good tips for dealing with credit card debts.