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Using a personal loan to payoff credit card debt - When it does and doesn't make sense

Morgue File Photo.

Americans are swimming in debt. Eight years after the Great Recession the average American household is still carrying nearly $5,000 in credit card debt. With the average interest rate of credit card debt at 15%, the minimum payment of $189 would take more than 10 years to pay that off, costing more than $18,000 in total interest. Feeling the strain of mounting credit card debt, an increasing number of people are considering a personal loan to consolidate their debt with the intent of reducing their costs. However, especially when it comes to personal finances, sometimes the best intentions are fraught with unintended consequences. Although replacing credit card debt with a personal loan may make sense in some circumstances, it should always be done with careful consideration of the potential drawbacks.

Why more people are turning to personal loans

The biggest reason why an increasing number of people are considering personal loans to refinance their credit card debt is because they are much more available than they have been. Online lending platforms and peer-to-peer (P2P) lenders have proliferated in the last several years, offering access to people who otherwise may not be able to qualify for a bank loan. They are much easier to obtain with an easy application process and quick approvals. However, they can also be more expensive than a bank loan.

According to, personal loans come with fixed terms and a fixed monthly payment. Some people might prefer that because it makes it easier to stick with a debt repayment plan. The major drawback is if they continue to use their credit cards without paying them in full each month, they can compound their debt problem. A personal loan should only be considered if you are able to stick with a strict spending plan that focuses on repaying the debt while living within or under your means.

When a personal loan might make sense

Lower your interest costs

If your credit is good enough to qualify for a bank or credit union personal loan with a 4 to 10% interest rate, then it may make since to replace credit card debt that averages 15%. However, if your credit is less than great, you might be limited to applying with an online platform lender where interest rates start at around 12% for people with good credit. As general rule of thumb, if you can lower your overall interest rate by at least 2 percentage points, it may be worth considering. Of course it never makes sense to replace one type of debt with higher costing debt, which may be the case for people with poor credit.

Consolidate credit card debt

Some people run into debt problems because they have too many credit cards. It can happen especially when a person receives 0% balance transfer offers that end up shifting debt from one card to another. If the balance is not paid off before the end of the introductory period, the balance can balloon under higher interest rates. It is fairly common for people in this situation to end up with five or six credit card balances. Just as a financial management matter, it may make sense for some people to consolidate their debt payments into one as long as they can commit to stop accumulating balances on their credit card. They can have just one payment automatically deducted each month, which may be easier to manage.

Faster debt repayment

Personal loans come with a fixed term and a fixed interest rate, which may offer a psychological edge for faster debt repayment. With terms of two to five years, there is a definite end game that can be targeted, enabling you to focus on one goal. It can get you out of the trap of making minimum credit card payments which can go on for years.

When a personal loan might not make sense

You don't have your spending under control

Before taking on more debt to replace debt, you need to seriously consider what got you into the place you're in. Unmanageable debt is only the symptom of a larger problem driven by behavior. If you are unable or unwilling to change your behavior, you will likely end up with an even bigger problem. Effective personal financial management is only possible with discipline and patience — the discipline to stick to a strict spending plan and the patience to delay gratification until you can afford it. Otherwise, a personal loan will only be a temporary fix that can lead to more problems in the long-term.

You don't have a real plan to become debt free

While it is possible to lower your interest costs, lower your monthly payments, and simplify your debt management, if you don't have a definitive plan to pay off your debt, a personal loan wouldn't make sense. For example, if your credit card payments amount to $600 and you find a personal loan with a payment of $450, you will add $150 to your budget. You now have a choice to add to your spending or pay down your debt faster. Which will you choose? If you choose paying down your debt, it is less likely to happen without committing to a plan with a clear goal to pay off your debt.

Your debt is out of control

If you have moderate debt that can be better managed with a lower cost personal loan, it might make sense. However, if you have significant debt with credit cards charged to the max, the problem is not likely to be solved by simply reshuffling the deck chairs. High credit card debt often translates to a lower credit score, which makes it very difficult to obtain a personal loan with a lower interest rate. You may be better off seeking debt counseling which can also offer the opportunity to consolidate your debt payment under better credit terms.

Should you or shouldn't you?

To determine if and when to use a personal loan to refinance your credit card debt it invariably comes down to a matter of math and behavior. If the math makes sense — i.e., lower interest rates = lower payment and costs over a shorter period of time — it should be considered. However, the more important consideration is whether you are able and willing to address the issues that led to your debt problem. A personal loan can either be a final solution or a stepping stone to bigger problems if your behavior doesn't change.