7 Reasons To Use A Personal Loan to Pay Off Debt
When you’re overwhelmed and juggling several bills with different interest rates and due dates — like credit card debt, auto loans, medical debt and student loan debt — consolidating your debt with a personal loan can help.
Using a personal loan to pay off your debts can help reduce the number of debt payments you’re juggling each month down to one. In some cases, consolidating your debts into a personal loan could even save you money on future interest payments as you pay down the loan balance.
7 reasons why you should use a personal loan to pay off debt
When you consolidate your debt using a personal loan, you’ll receive a lump sum cash loan, which you can use to pay off the debts you want to consolidate in full. Now, all you need to focus on is repaying the personal loan.
That process is simplified with personal loans, as they are installment loans that generally charge a fixed interest rate. Installment loans are paid back to the lender in equal payments, over a set period of time. You’ll make equal, monthly payments until you have completely paid back the loan and any interest and fees charged.
Here are 7 reasons it may benefit you to consolidate debt with a personal loan:
Save on high-interest debts
When you use a personal loan to consolidate debts with higher interest rates, you can potentially save money on interest payments over time as you repay the debt. The key is to secure a personal loan with a lower rate than your existing debts, which is easiest to do if you have a good credit score.
You’ll also save on interest indirectly by consolidating: going from multiple loan payments to just one loan payment makes it easier to avoid the late charges and other penalties you’d incur as a result of late or missed credit card payments. Those fees simply add to your total loan balance and lead to higher interest charges.
Double check the debts you intend to consolidate to ensure they charge a higher annual interest rate, or APR, than the personal loan you intend to use. If you get offered a personal loan that charges 6% APR, for example, you wouldn’t want to use that loan to consolidate a student loan you have that’s been charging you 4% APR.
Have one single payment
If you’re having trouble keeping up with due dates and payments on multiple debts, consolidating all of your debts into one loan with one monthly payment can help you get organized. When you consolidate debts with a personal loan, instead of worrying about juggling several debts that arrive on different due dates, you’ll only have to keep up with one debt payment each month.
Pay off loans at a fixed rate
Personal loans generally charge a fixed interest rate, so if you use one, you shouldn’t be surprised by any sudden rate changes like you would with credit cards or personal lines of credit, which typically charge variable rates. Lenders have their own rules for what factors can include a rate change so keeping up with rate changes can be difficult. When you use a personal loan to consolidate your variable-rate debts, you get rid of that headache.
Know what you’ll owe each month
A personal loan is an installment loan, so it’s paid back in equal portions over a fixed period of time. The interest and fees are already included in your monthly loan payment, so unlike with credit card debt, your payment will likely be the same amount each month. Knowing how much you’ll owe ahead of time takes the guesswork out of your budgeting and makes the payments on a personal loan easy to plan and save for.
Pay off debt for good
Personal loans, when used in debt consolidation, can be a useful tool to finally dig yourself out of debt — for good.
This works if, when you consolidate your debts, you
- make sure to base the monthly payment you’re able to afford on your budget and;
- try to avoid using credit cards and accumulating unsecured debts after you’ve paid off the balances using the personal loan.
When you’ve paid off your loan — if you haven’t racked up other unsecured debts in the time — you’ll be done with those debts for good.
Rebuild your credit score
If you use a personal loan to pay off credit card balances, it can help to reduce your credit utilization rate. Your utilization rate is how much of your overall credit limit you are using up and is the second most important factor in determining your credit score. It’s recommended your credit utilization stays below about 30% for good credit health. For example, if your overall credit limit on all of your accounts is $10,000, your goal would to use less than $3,000 of it.
A personal loan is repaid in equal payments on a fixed payment schedule, so you’re able to budget for future payments. Establishing a pattern of on-time payments can help your credit score. If you set up automatic payments, they can be made on time each month and make this easier. Finally, having the personal loan helps to add diversity to your credit mix, a factor that accounts for about 10 percent of your credit score.
Get your money fast
Most lenders will allow you to apply for a personal loan online. Generally, you should know if you’re approved and offered loan terms within minutes. If you accept, you’ll likely see the funds in your bank account in a few days — and some lenders even offer financing in as little as one day. The speed can come in handy if you’re eager to get moving on your debts and started on your journey to becoming debt free.
But be sure to focus more on fees and the APR on your loan than funding speed when you’re comparing loan offers. If you get the cash fast but end up paying a significantly higher APR or getting stuck with a high origination fee, it may not be worth it to pass up a slower-funded loan with lower rates and fees.
What to consider before paying off debt with a personal loan
It’s easy to fall back into the debt trap if you’re not careful
When you use a personal loan to consolidate debt on an unsecured line of credit (such as credit card debt), you pay off the other debt, meaning that line of credit is back open for use again. If you’re not careful, you could get yourself back into trouble, or worse.
“A lot of people use a cash infusion to pay off debt with good intentions, but end up in worse debt than they started,” Melinda Opperman, Executive Vice President with Credit.org, a non-profit credit counseling agency, told LendingTree.
The difficulty comes in having the discipline not to dig yourself back into debt — or into even more debt — once the balance on credit cards are open to use again.
“Someone who is really committed to living on a budget and staying debt free could take advantage of the benefits of personal loans, but our experience has taught us that this is much more difficult than it seems at first thought,” said Opperman.
Research other methods to pay off debt
A personal loan can provide significant benefits when used properly in debt consolidation. But if you don’t think a personal loan is the right option for you, you can consider debt consolidation alternatives, like trying a debt management plan with the help of a debt counselor or transferring your balances to a 0% interest balance transfer credit card.
Try a balance transfer credit card
If you’re looking to consolidate unsecured credit card debt, you may want to consider a balance transfer as an alternative to using a personal loan. When used properly, balance transfer credit cards can save you money on future interest payments and help you get your debts under control.
How it works
When you do a balance transfer, you transfer the balances on your credit cards to another credit card with an intro 0% APR offer. Intro offers typically last from six to 18 months.
You can transfer the balance to a credit card with a lower interest rate as long as the new credit card is issued by a bank that’s not affiliated with the one currently holding the debt. But generally speaking, a balance transfer credit card — a credit card that offers 0% interest for a promotional period of time — may serve you best. The cards may charge a one-time balance transfer fee, which can range from 2 to 5 percent. The interest-free period allows you to avoid paying interest as you focus on paying down the balance. The promotional period varies from card to card.
— Learn more about using balance transfers to pay off debt here
A HELOC or Home equity loan
If you have enough equity built up in your home, you may be able to take out a home equity loan of a Home Equity line of credit. A home equity loan or a HELOC can be a strategic debt consolidation tool if you use it to consolidate debts that carry higher interest rates like student loans or medical debt.
How it works
A home equity loan functions similarly to a personal loan. You’d receive a lump sum cash loan to pay off the debts you want to consolidate, then pay back the home equity loan in installments, at a fixed interest rate.
A home equity line of credit (HELOC) operates similarly to a credit card. It’s a line of credit with a set credit limit. You can borrow from that limit anytime while the line of credit is open to pay off your debts. Because you only pay interest on the amount of money you use from the line of credit, your payment may not be fixed each month. In addition, the interest rate on a HELOC will usually vary with the market, so your rates could change anytime affecting your monthly payment.
Using a HELOC or home equity loan to consolidate debt is a risky move because the loan is backed by the value in your home, so you risk losing your home if you run into financial difficulty in the future.
What to look for when applying for a personal loan to pay off debt
When you’re shopping around for a personal loan for debt consolidation, you may get a myriad of loan offers — different amounts, different interest rates and varying terms from bank to bank. Here are a few tips to make sure the loan you eventually decide on fits both your financial need and your budget.
Look for the lowest interest rate
Don’t simply look for an interest rate that’s lower than the rate you’re currently paying on the debts you want to consolidate; that’s only a start. But for the most cost savings, you should shop around and compare rates on the personal loans you are offered. Your best bet is to go with the loan with the lowest interest rate you can find on payment terms that fit your budget.
Consider the length of the loan
You should choose a personal loan with the shortest term you can find on a payment that fits within your budget. The length of the personal loan you use to consolidate debt matters. Because personal loans generally have high-interest rates, the shorter your loan term is, the more you’re likely to save on interest payments.
Consider what you can pay each month
The whole point of debt consolidation is to help you be able to afford your debt payments each month, so the last thing you want to do is take out a debt consolidation loan you can’t afford. Look for a personal loan with payment terms that match your budget and compare options before you decide on a loan. LendingTree, has a loan calculator you can try out to see what your possible monthly payments would be on the personal loans you’re offered.
Avoid hidden fees
Carefully read through the terms of each personal loan you’re offered, so you don’t miss any hidden fees that add to the overall cost of the loan. For example, most lenders charge what’s called an origination fee, which covers the lender’s cost of processing the loan. That fee is usually deducted from your total loan amount; it may be explained in the fine print, but can easily be missed. It could come as an unexpected surprise when you get a loan amount lower than what you expected. An origination fee is generally unavoidable, but you still want to compare what each loan charges you to get the best deal.
In addition, look out for any mention of prepayment penalties if you plan to pay off the personal loan before the loan term ends. A term you should keep and eye out for is “pre-compute interest” — it’s definitely something you want to avoid if you plan to pay off your loan early. A pre-computed loan uses a complicated interest calculation that ensures you end up paying a higher interest rate if you pay off your loan early.
In addition, avoid any added insurance policies you don’t want (like life insurance or unemployment insurance, for example) the lender may pitch to you.
Where to find the best personal loan to pay off debt
Banks, credit unions, credit card companies and online lenders all offer personal loans you can use to pay off debt, so there are tons of options out there.
To help sort out your best options, LendingTree analyzed lending requests and created this table of the top lenders for borrowers according to credit score level. Generally speaking, borrowers with good credit scores or better are more likely to be offered the best loan terms.
I’ve found my personal loan, now what?
Once you’ve consolidated your debts using a personal loan, the real work begins. You need to stick to your plan to eliminate the debt in order to reap the benefits of debt consolidation.
Follow a budget
You may have created a budget to find out how much of a personal loan payment you’re able to afford. If you didn’t, go ahead and create a budget that takes your loan payment into account. According to Randy Williams, president of A Debt Coach, a non-profit credit counseling agency in the Cincinnati metro area, the next step of budgeting is to “actually fulfill our goals.”
“A lot of times we get it all set up and ready to go then we allow life to interfere,” said Williams. “Once we get a plan set in order you have to go after it.”
Focus on following the budget you’ve created and building savings habits, such as cooking at home instead of dining out and avoiding impulse purchases. There are many different strategies you can try, like this budget, designed specifically for eliminating debt, or this zero-sum budgeting strategy. In addition, several services such as My LendingTree exist to help you get your financial goals and spending habits on the same page.
If you’re new to budgeting or generally struggle with financial discipline, Williams recommends contacting a credit counselor and checking out budgeting programs they have and successful strategies.
Address your spending problem
Chances are, you didn’t acquire all of the debt you want to consolidate overnight. For example, with credit card debt, the mountain of debt was more likely built over time by bad spending habits. Those habits need to be checked once your credit cards are paid off, or else you may end up in the same situation again.
“You may have saved yourself some money or some interest, God bless you, now cut those credit cards out,” said Williams. “You’ve got the spending habit that’s never been solved. All you do is fix it with consolidation.”
Williams says using a personal loan to consolidate credit card debt can be a quick fix for your spending problem, but it can backfire if you don’t address the issue at heart. In those cases, he recommends you address and resolve your spending problem so that you don’t end up having to take out another debt consolidation loan to get out of credit card debt.