Using a Personal Loan for Credit Card Debt Consolidation

Reader question: “I have a lot of credit card debt that I would like to consolidate. I am paying a pretty high interest rate on a couple of the cards, and it makes me sick to my stomach when I submit my payments each month. It seems like debt consolidation would be a good idea at this point. There’s the convenience factor of paying one bill each month, instead of four. I’m also hoping to reduce the total amount of interest I pay in the process. My question is, can I use a personal loan for credit card debt consolidation? Does it make sense to use this strategy? And what are the downsides, if any? Thanks in advance.”

Yes, you can use a personal loan to consolidate the accumulated debt from two or more credit cards. Many consumers use this strategy to simplify their finances and, in some cases, save money in total interest payments. Will it work out for you? Maybe. This is a question only you can answer. But don’t worry. I’ll give you the information you need to make a smart decision.

Much of it will depend on the interest rate you receive on the personal loan, and how it compares to the current amount of interest you are paying right now. You can easily do the math to see how it will pan out. The rest is easy. If you have a decent credit score, you’ll find plenty of banks willing to give you a loan for credit card debt consolidation. Just remember to do the math to see how much you might save on your consolidated debt, compared to the diversified payments you are making right now. Here’s how to get started.

Personal Loans: One of Several Ways to Consolidate Debt

The personal loan is one of several strategies for debt consolidation. Cash-out refinancing and home equity loans can also be used to consolidate credit card balances. With all of these methods, you are basically replacing several sources of debt (such as credit cards) with some form of new financing. The end goal is the same, regardless of the strategy you use. You want to reduce the total amount of interest you pay on your debt, over the months and years to come.

You’ll also simplify your finances by reducing the number of bills you have to pay each month. But this is a secondary concern. Your primary goal is to save money in total interest costs. Consolidating credit card debt with a personal loan is one way to achieve this goal … if the numbers work out in your favor.

If you don’t currently own a home (or don’t want to use it as collateral for new financing), you could use a personal loan for debt consolidation. Personally, I would never use equity-based financing to consolidate other forms of debt. My home is to important to me. I would use the personal-loan strategy long before I would ever think of tapping my home equity. But I digress.

So why do people use personal loans for credit card debt consolidation? It has to do with the interest rate. The rate on a personal loan typically falls somewhere between a home equity loan and a credit card. They are higher than the former, but lower than the latter. In theory, you could use a personal loan to pay off the amount you owe on your cards. If you can secure a lower rate in the process, you may end up paying a lot less interest over time. I say this “in theory,” because it doesn’t always work this way.

Let’s look at some actual numbers:

• At the time this article was published, the average interest rate for a home equity loan was around 6% (according to Bankrate.com).
• The average rate for a credit card was closer to 15% (according to Creditcard.com).
• Depending on your qualification, the rate you receive on a personal loan will probably fall somewhere in between the two numbers above. It will probably be higher than 6% but lower than 15%.

This is why some people use home equity loans for credit card debt consolidation. Let’s say I have three cards with a combined balance of $6,500. The average interest rate across all three cards is roughly 17%. Let’s further assume that I use a home equity loan to pay off all three of those high-interest accounts. Now I’ve got a rate of 6.5% for the same amount of debt. Seventeen percent of $6,500 is $1,105. Six-and-half percent of $6,500 is $422. You can see the potential for savings. A larger amount of debt would bring an even greater potential for savings.

Does It Pay Off in the Long Run?

But what about using personal loans for credit card debt consolidation? Does it always work out to the borrower’s advantage? No, not always. It will largely depend on two things:

• The difference between your credit card rate and the interest rate you receive on the person loan, and…
• the amount you pay in fees to secure the new loan (if any).

So the first thing you need to do is find out what kind of rate the bank is willing to give you on the new loan. Compare this to the average rate you are currently paying on your credit cards. Next, find out if the bank is going to charge you any fees. Once you have all of this information, you can easily calculate your savings over the life of the personal loan. Just keep in mind it doesn’t always work out to your advantage. You need to do the math. If you’re not savvy with these types of calculations, you might want to get help from a non-profit financial counselor. Take a look at NFCC.org, for starters.

Here’s a general rule of thumb to use when considering a personal loan for debt consolidation: Take a look at the monthly payments you are paying on your credit card balances right now. Compare this to what your payment will be on the personal loan (the bank should be able to tell you this, based on the rate they are offering). Be sure to factor in whatever fees they are charging — some of these fees might be rolled into the loan. If you’re not saving at least 5% on your monthly payments after the deal is done, you might want to reconsider the personal loan strategy.

Disclaimer: This article outlines the considerations you should make before using a personal loan for credit card consolidation. This information is provided for educational purposes only. This website is not meant to take the place of financial counseling. Every borrower is different, so every lending scenario is different. We recommend that you seek guidance from a financial counselor before making a decision.