Refinance Credit Card Debt With a Personal Loan
If you have high credit card debt and are struggling to keep up with the payments, you should explore getting a personal loan to consolidate your debt. Here's why and how to do it.
If you have credit card debt, you're not alone.
According to the Federal Reserve, Americans currently have more than $1 trillion in credit card debt, which amounts to about $8,109 per household.
In your case, if a mounting credit card balance is dragging you down month after month, the first question you need to ask yourself is how you got to this place.
You may think the only reason was being a bit too careless with shopping, traveling, or eating out — or thinking that you could spend a little extra right now and pay it back later.
But chances are you also got trapped in the predictable and vicious circle of credit card debt.
We've all been there: it happens when one more purchase you couldn't afford at the moment pushed you over the edge of what you can afford to pay every month.
In my case, I once used a nearly maxed-out credit card to purchase a website out of sheer impulse, hoping to turn a profit.
Next thing you know, you're just making the minimum payments, but you're not making a dent in the principal of your debt.
You think you're doing okay, but the reality is, you're covering just the interest of a very expensive loan while the amount you owe basically stays the same, month after month.
Even worse, using a large chunk of your available credit (i.e. a high "credit utilization ratio") is damaging to your credit score—and could even negatively affect your ability to find a job.
It is a trend that keeps growing as Americans now have the highest credit card debt in U.S. history, according to the Federal Reserve.
The important thing to realize is that you can get out of it — but depending on how committed you are, it may take a considerable amount of effort and discipline for maybe a couple of years.
There are several ways of paying off your credit card debt, but one of the most efficient is taking out a personal loan in order to achieve debt consolidation.
Because you can replace everything that you owe on your credit cards with a single debt consolidation loan that will have monthly payments with a fixed, lower rate.
You will also know exactly when the payments will end instead of being trapped in an endless cycle of barely-above-the-minimum payments.
It will also bring you peace of mind and heal your personal finances by reducing your debt-to-income ratio.
Now, let us show you how a personal loan can help you get your credit card debt back under control.
There are several steps to paying your credit card debt, but the first one of them is to make a plan.
This includes stopping the debt from growing, deciding if you should consolidate your debts, and considering whether a personal loan is the right option for doing so.
Before anything, you need to stop using the cards that have the debt that is causing you trouble
In many ways, credit card debt is like a wound—you need to stop the bleeding before it can start to heal.
That means you should stop using the card with the high balance and find a way to pay it down as soon as possible, ideally in one big payment.
If you stop adding to the debt, you will be able to stop the vicious circle of paying interest and fees every month which prevent you from actually making a dent in your debt.
Once you've done that, the healing may begin.
Next, you need to figure out if debt consolidation is the right option for you
Consolidating your debt is not the only way of dealing with your credit card problem, and each one has its pros and cons.
If you're behind on your payments, you may explore debt settlement. This is the process of negotiating with creditors to lower your debt.
The negotiation is conducted by a third party, but even if you succeed in doing so, there is a catch: It can potentially damage your credit score and will remain on your credit report for seven years.
You can also try a program of debt management. This strategy used by credit counseling firms doesn't involve borrowing money or reducing the principal of your debt.
Debt management means that credit counselors will work with the card companies to accept reduced interest rates and lower payments.
But the debt management programs come with a cost.
They normally charge you an origination fee, followed by a monthly fee that ends up folded into your monthly debt payment.
If you have a good credit score (670 and up) and want to keep it like that while avoiding the costs and complications of debt settlement or debt management, then you should definitely explore debt consolidation.
With a good credit score, you will also be able to get a personal loan that has a lower interest rate than what you're paying on your credit card debt.
Determine if you should consolidate credit card debt with a personal loan
There are many ways of consolidating your debt, and a personal loan is just one of them.
Transferring your balance to a 0% APR card is a popular option. Many people take advantage of promotional offers for a new credit card with your transferred debt at a 0% APR for periods that range 6–21 months.
But even if you qualify for one of these deals (which normally require having good credit) that covers the total of your debt, there are risks and costs associated with it.
0% APR cards will charge a balance transfer fee. It is normally 3% of the debt you're moving into your new card.
The 0% APR is always a temporary offer. After that period is over, the interest rate will go up to a regular one, normally above average.
If you haven't managed to pay off the principal of your previous card's debt or even make a dent in it, then you're exactly where you started.
You may even be in a worse spot: your new interest rate could be higher than the one you were paying on your original card.
A late payment regularly ends the temporary 0% APR. If you're late, you'll most likely start paying a penalty rate of 20% and above.
So a 0% APR credit card transfer is not necessarily the best option for everyone. And it may create the illusion that you're dealing with your debt when in reality all you're doing is kicking it further down the road.
Another option is taking a loan from your 401k to wipe your debt. Many employers allow for workers to borrow up to half their retirement balance for periods of up to five years, with a credit limit of $50,000.
This alternative has many pros:
- It doesn't affect your credit score
- You're paying interest to yourself
- The interest rate on a 401k loan is normally cheaper than that on credit cards
But borrowing from your 401k also has its cons:
- It's not available to everyone, and if you lose the job feeding the 401k, the lender may request to pay it in a shorter term.
- It poses a risk to your hard-earned retirement savings if you're not able to keep up with the loan
- It could carry tax consequences and penalties
A personal loan has its own advantages
Determining if a personal loan is the right option to pay your credit card debt—or if you should use the other popular option of a 0% APR transfer balance credit card—can be tricky.
But here's the gist of it: if you have good credit and you're sure you can pay off your debt well within the introductory zero-interest period, then you should go with a balance transfer credit card.
Again, you need to be committed—and have a plan—to pay all or most of your balance before the 0% APR rate expires; lest you want to risk being subjected to above-average interest rates when the honeymoon period is over.
A personal loan can give you more time to pay than a 0% APR credit card. Balance transfer deals usually range 6–21 months, so if you need more time, you probably want a personal loan to get out of the hole you're in.
Personal loans also give you an extra push to keep up with your payments. One of the most dangerous things about credit cards is that you can keep adding debt to them even as you try to pay them off.
And if staying on top of that is hard for you, the fixed payments can be a great psychological help you stick to your payment plan.
The key is getting a personal loan with a lower APR than your credit card. Go to a few sites—see Lending Club or Lending Tree, for instance—and see available offers based on market and personal conditions.
Then, use a personal loan calculator to see what your monthly payments would be.
Find the Right Loan for You
Before you apply, learn the basics of personal loans and what you'll need beforehand
There are two types of types of personal loans: secured (where you put up a collateral, like a car) and unsecured.
When you're looking to consolidate credit card debt, you're probably looking at an unsecured one.
The term on personal loans can range from a few months to five years. It's typical for lenders to offer lower interest rates for longer loan terms.
Most lending institutions can get you an unsecured loan for up to $10,000. But there are other options, and a top personal loan lender like Wells Fargo offers amounts that go as high as $100,000.
The interest rate will depend on your credit score and loan length. Personal loans can range widely from 2.5 to 36%, but if you're a borrower with Good credit (690+), expect to pay around 8.5–14.5% for a five-year term loan.
The average borrower pays 10.64% on a 24-month term given by a commercial bank.
What does that mean?
For instance, suppose you owe $10,000 in credit card debt and have an APR of 16.5% (roughly the current national average), it would take you 48 months to pay the debt with a monthly payment of $286.
Now assuming you have a "Good" credit score (690+), you can get a personal loan with an interest rate of 13.5%, and erase your debt in the same period by paying $271 per month.
If your credit is "Excellent" (720+), you will get an even lower APR.
That may seem like a small difference in your monthly bill, but it adds up over time and, more importantly, the interest rate on your personal loan won't change like it would on a credit card.
You will also not be subject to the penalties of a credit card nor be tempted by your card provider to keep adding to that debt by constantly using your card.
Things to do before applying for a personal loan
If you've decided to go ahead and apply for a personal loan, here's what you need to do:
- Find out your credit score
- Before applying, try to boost your score. You can do so by making credit card payments on time, making a large payment, and disputing any errors your credit report may contain
- Get pre-qualified for a loan. This will not affect your credit score.
Here's what a potential lender may ask when pre-qualifying you for a personal loan aside from your basic personal information:
- Your Social Security number
- Your annual income
- The amount of your monthly debt obligations (rent, student loans, etc.)
- Employer's name, work address, and phone number
- Previous addresses
- College history and major
- Mother's maiden name (or similar information for security questions)
Get the best possible personal loan for you
There are many options out there, from large commercial banks to credit unions to peer-to-peer lenders, and a bit of legwork could save you a lot of money in the long run.
Your goal is to lock the best possible personal loan rate, get flexible terms, and know that you'll be able to trust your lender as much as they'll trust you.
The key here is shopping, shopping, shopping. And the best way to do so is by starting with the 8 best places for personal loans.
Of course, it also pays to find a company that truly cares for you.
Pay the Loan Off for Good
Stop me if you've heard this one before, but after getting that loan you'll need to pay it.
And for this, you'll need a plan. The good news is that a personal loan will give you a fixed interest rate, so you'll know exactly how much you'll be paying every month.
The only thing left to do is to set a fixed amount of money apart in your personal budget to cover your loan every month.
If you didn't have a budget before amassing that credit card debt, now is the best moment to start. There are many ways to set up a budget.
There are payment methods other than personal loans
If the numbers work out (i.e., you get a personal loan with an interest rate lower than what you're paying on your card), then you will be able to pay off your credit cards in one go.
But sometimes it's not necessary to apply for a loan.
In many cases, you can employ either the "avalanche" or the "snowball" method of paying off credit cards to great effect.
The avalanche method suggests you pay the minimums on all credit card debt and any extra money goes to the card with the highest APR first.
Once that card is paid off, you move on to the next.
The snowball method, on the other hand, suggests you pay off the card with the smallest debt first.
Once you've paid off that card, you move to the next one, until finally, you're tackling the card with the biggest balance.
Although you're not addressing the card with the highest interest rate first, you are immediately able to score little victories.
Do whichever is most effective for you. The key is getting rid of that debt!
Don't close your cards
Closing credit cards will not help your credit score. In fact, it may actually damage it.
So unless the card you were using has an annual fee that can't be waived or that you no longer wish to pay, it's better to just keep them open and put that piece of plastic you keep getting in the mail in a drawer.
You could even cut them in half.
You simply don't want to repeat this cycle of debt again.
Since 1998, CreditLoan has been helping to educate consumers on financial issues while providing the tools and solutions they need to effectively manage these issues.
Whether you're working on a better budget, establishing joint accounts, getting a loan on bad credit, or buying your first home, CreditLoan.com has the advice you need from experts you can trust.
Have you refinanced your credit card debt before?
What was your experience and who did you go with?
Would you do it again?
Let us know in the comments below!