Should you take out a loan to pay off credit card debt?

A young woman with long brown hair is lying on her sofa, credit card in hand, looking at her tablet, as suns streams through the large windows behind her.Image: A young woman with long brown hair is lying on her sofa, credit card in hand, looking at her tablet, as suns streams through the large windows behind her.

In a Nutshell

Taking out a loan to pay off credit card debt may help you pay off debt faster and at a lower interest rate. But you might only qualify for a low interest rate if your credit is good. And personal loans can come with fees that may offset any interest savings.
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Considering a personal loan to pay off credit card debt?

Some personal loans offer lower interest rates than credit cards. So consolidating your credit card debt with a personal loan may save you money on interest and potentially help you get out of debt faster.

Read on to learn about the potential pros and cons of a personal loan for debt consolidation as well as possible alternatives.

Benefits of using a personal loan to consolidate credit card debt

Using a personal loan to pay off credit cards may make sense in certain situations. Here are some of the potential benefits.

Lower interest rates

Personal loans tend to offer lower interest rates than credit cards. The average annual percentage rate for credit cards was 19.07% in November 2022, while the average rate for a 24-month personal loan was 11.23%, according to the Federal Reserve. And if you have excellent or good credit, you may quality for an even lower rate. Consolidating your credit card debt into a personal loan with a lower rate could help you save a significant amount of money in interest.

But keep in mind that lenders typically have minimum loan amounts of $1,000 to $5,000. If your debt is below this range, a personal loan may not be the right fit.

Reduced chance of missing a payment

Multiple credit card balances means making multiple payments each month. Consolidating all of your card debt into a personal loan means just one fixed monthly payment to remember. This can reduce the chance that you’ll miss a payment, which can negatively affect your credit.

Improved credit scores

Applying for a personal loan will likely result in a hard inquiry, which can initially ding your credit. But in the longer term, a personal loan could boost your credit in a couple of ways. First, it can increase your mix of accounts. A healthy mix of account types, such as loans and lines of credit, can help build your scores.

Second, using a personal loan to pay off one or more credit cards can help improve your credit utilization — your total credit card balances divided by your total card limits. Having a lower credit usage ratio (generally, below 30%) can help increase your score.

Downsides of using a personal loan to pay off credit cards?

Your monthly payment may be higher

While your interest rate with a personal loan may be lower than your credit card rates, you may find that the monthly payment for your new loan cuts deeper into your monthly budget.

With a fixed-rate personal loan, “you’re locked into a set monthly payment for a specific period of time, and this monthly payment may be higher than the minimum payments on your credit cards,” says Shannon McLay, founder of financial services company The Financial Gym.

Use a loan calculator to see how much your loan payments might be.

Your loan may come with fees

Another issue to look out for: Fees can add to the cost of your loan and eat into whatever you might be saving on interest. Some lenders charge loan-origination fees for processing your new loan. Typically, the origination fee is a small percentage (generally 6% or less) of the total loan. This fee may be included in the loan amount — which means you’d be paying interest on the fee as well.

Also, watch out for prepayment penalties, which are additional fees that lenders may charge for paying off your loan early.

You could end up in greater debt

If you continue to use your credit cards after taking out a personal loan, you’ll rack up even more debt. Before accepting a loan offer, make sure the monthly payment fits into your budget, and create a plan to avoid using your cards.

What type of loan is best for paying off credit cards?

There’s no one-size-fits-all solution for chipping away at credit card debt. Apart from personal loans, here are some other potential ways to consolidate your card debt.

Balance transfer credit card

Beverly Harzog, credit card expert and author of “The Debt Escape Plan,” suggests balance transfer credit cards as an alternative to personal loans for paying off debt.

“If you have excellent credit scores, you may be better off getting a balance transfer credit card that offers a 0% introductory APR,” Harzog notes. “This way, you can pay off the debt without paying interest.”

Of course, this is only true if you’re able to transfer all of your balances and you pay off your balance before the introductory APR period expires.

Home equity loan

If you own a home, a home equity loan may be an option. With this type of loan, you borrow money by tapping into the equity you have in your home. While a home equity loan may come with a lower interest rate than a personal loan, you risk losing your home if you can’t repay the loan.

401(k) loan

If you have a 401(k) plan, you may be able to borrow against it. But these types of loans come with substantial risks, so be sure to consider all of your options before opting for one.

As with other loans, you’ll need to repay a loan from your 401(k) — with interest — within a set loan term (usually no more than five years). But because you’re borrowing your own money, you’ll be paying yourself back.

Keep in mind, though, that some plans don’t allow participants to make plan contributions while you have an outstanding loan. That means you could miss out on years of saving and any matching contributions your employer offers.

Next steps

If you decide that a personal loan is the right option for you, make sure you do your homework: Check your credit scores, compare loan rates, read the terms and conditions, and be on the lookout for costly fees.

“It’s a good idea to check with a local credit union or your own community bank and see if you can get a personal loan that way. There are also loan comparison sites that can help you find the best rates. When you choose a lender, check the Better Business Bureau to see if there have been any complaints,” Harzog says.

If you’re not sure a loan or balance transfer card is a fit for you, consider other ways to pay down your debt, such as the snowball or avalanche method.

About the author: Melanie Lockert is a freelance writer and editor currently living in Portland, Oregon. She is passionate about education, financial literacy and empowering people to take control of their finances. Her work has been f… Read more.