Should you use a Personal Loan to pay off Credit Card debt

Should you use a personal loan to pay off your credit card debt?

Let’s find out. In this article we’ll discuss some of the pros and cons of personal loans to help you decide if it’s the right option for you.

According to official statistics released by The Reserve Bank of Australia (RBA), Australian households have credit card debt totaling over $27.2 billion. If you are currently dealing with credit card debt and want to pay it off for good, a personal loan could be a good way to get yourself out of hot water.

Credit cards make it almost too easy to buy anything at any time. Couple that with enticing rewards on your spending and you can find yourself racking up debt from all directions. Unfortunately, of all the types of debt you can have, credit card debt is one of the nastiest. There are many risks to consider before making a habit of paying with plastic.

Struggling to pay off credit card debt can lead to a life full of stress and anxiety. Understanding your monthly budget, prioritising your credit card payments, and using tools to lower your interest rate can help you form a realistic plan to become debt-free and relieve your heavy financial burden. Many experts say the best way to rid yourself of credit card debt is to cut up your credit cards and switch to a cash only budget. This is sound advice. As long as you have a credit card, you’re going to be financially dependent on it, which is not a good way to be.

Normally, I wouldn’t suggest taking out a personal loan to pay off debt. There are, however, some situations where a loan can help you pay off debt and save a little money week to week. If you have credit card debts with overly high interest rates and cannot seem to get ahead because you still have to use the credit card, ditching plastic and consolidating debt with a personal loan might turn out to be the best decision you’ll ever make.

It’s important to understand that a personal loan won’t reduce or eliminate your debt. What it can do is help lower interest, in turn reducing your monthly repayment and saving you money. Many personal loans do require an up-front fee or a recurring monthly fee on top of your regular payments so it’s important to weigh up your options.

Why are personal loans so advantageous when it comes to getting out of debt?

Why shouldn’t you just keep making payments on your credit cards instead?

This all depends on the interest rate you can qualify for on a personal loan. Credit cards come with an Average Percentage Rate of more than 18 percent. If a personal loan interest rate works out to be much less than your credit card interest rate, you may be on to a winner.

A personal loan can be used for just about anything. Some lenders want to know what you will do with the money they lend you, but as long as you’ve borrowed it for a responsible and legal reason, you can use it however you please. Getting a personal loan should never be a case of walking into your bank and signing on the dotted line. You’ve got to shop around and find the most suitable option for you, from the most reputable lender.

There are many places you can find a personal loan. A new crop of online lenders makes taking out this type of loan quick and easy. You can also investigate peer-to-peer lending marketplaces to get your loan funded by a group of investors. If that new loan has a lower interest rate than your credit cards, you should think about moving forward with the consolidation.

What to look for when taking out a personal loan

Interest rate: An interest rate is an amount that a bank or financial institution charges on top of money loaned. The interest rate charged on your personal loan will make a significant difference to the lifetime cost of your debt.

Ideally, you want to choose a personal loan that can offer you the lowest possible interest rate so you can focus on paying off the money you borrowed rather than the extra interest. How high or low your personal loan interest rates are can depend on a few things:

  • Whether you choose an unsecured or secured personal loan. If a loan is secured with an asset, the rate will be lower than a loan which is unsecured.
  • Your credit score.

Fees:  Every loan will have a different range of fees associated with it. While many lenders do not charge any fees for personal loans, some will charge a loan set up fee. Make sure you check what, if any, fees a lender is going to charge. You might be surprised at what you find.

Fees you need to look out for include:

  • Establishment fee
  • Servicing fee
  • Early exit fee
  • Early repayment fee
  • Insurance fee
  • Withdrawal fee

Make sure you take the time to consider these fees when deciding on the type and term of your loan to avoid any unnecessary expenses.

Loan Term: Getting a personal loan with a longer loan term might seem like an attractive option because your weekly repayments are smaller. It’s important to remember that the longer the loan term, the more you pay during your loan period.

For example:

Borrowing amountLoan termInterest rateWeekly repaymentLifetime Repayment (loan plus total interest)
$10,0002 years12.73%$217$22,602
$10,0005 years12.73%$103$26,848
$10,0007 years12.73%$82$29,925

Balance transfer or personal loan?

When it comes to consolidating debt and lowering your interest expense, credit card balance transfers and personal loans can be two effective ways to do so. However, there are pros and cons to both options.

In my experience, I find it helpful that personal loans allow you to make a fixed monthly payment with an interest rate that will never change. Personal loans don’t generally offer a zero-interest promotional period, but the interest rate on personal loans may be lower than a credit card’s standard interest rate.

With a balance transfer credit card, you can secure a 0% Annual Percentage Rate (APR) on transferred balances for up to 24 months. A balance transfer card may be the least expensive option if you can pay off the entire debt before the introductory period ends. If you don’t repay all the debt, you’ll accrue interest on the remaining balance at the card’s standard APR (often 12 to 23 percent depending on your credit).

It makes the most sense to take advantage of a balance transfer offer if your debt is relatively small and you’re confident that you can pay it off in its entirety before the 0% intro APR period ends. For some people, another credit card just means more open credit and more opportunity for the debt to pile up. In those cases, a personal loan can be a smarter option if it means you will stop using credit and stick to cash or debit instead.

Final Thoughts

For some reason, personal loans tend to come with a stigma that credit cards don’t. Personal loans can be useful, given the right circumstances. For example, most people can’t afford to pay cash for a home, making a mortgage loan a necessity. A personal loan can be a good idea when you use it to reduce your debt through consolidation.

In any case, be sure to consult with a trustworthy financial institution and weigh your options before making any rash decisions.

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