Personal Loans

How Personal Loans May Be a Cheaper Alternative to Credit

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As interest rates continue to rise, many consumers are grappling with increasingly large credit card balances. According to Experian’s latest State of Credit Cards report, total credit card debt in the U.S. has surged by more than 30% in just five years. Meanwhile, the average credit card balance has climbed to $4,293, which is up 11% from 2015.

Rising interest rates on credit cards and other variable-rate loans — which have largely been driven by steady rate increases from the Federal Reserve — are making it pricier to carry a balance. According to the Federal Reserve, the average APR on credit cards has climbed by almost 3 percentage points since 2014.

If you, too, are contending with extra large balances, it’s crucial to pay down your debt as quickly as possible if you’re dealing with high APRs. Otherwise, you could wind up paying significantly more in interest if APRs continue to increase.

You may also find that other forms of credit, such as personal loans, are a less expensive way to finance big purchases in the future, especially if you don’t think you can pay off your loans relatively quickly.

How to shrink — or avoid — a high-interest credit card balance

Some of the most popular ways to deflate a credit card balance are to transfer your debt to a low-interest credit card or a balance transfer credit card with a 0% introductory period, or to consolidate your debt with a lower-rate personal loan.

You can use a credit card or personal loan to fund new purchases, such as a kitchen remodel or a cross-country move.

Which choice is best for you depends a lot on your personal circumstances. April Lewis-Parks, director of education at Consolidated Credit, said you’ll want to look at a range of factors before deciding on a debt payoff strategy, including your income and credit score, your loan balances and how much time you think you’ll need to pay off your debt.

“It’s all about crunching the numbers,” Lewis-Parks said. For most people, the best strategy will come down to which one saves you the most money.

Why a personal loan?

Personal loans are often a good option for consumers who have a lot of debt but need some time to pay it off. Some personal loans give consumers up to six or seven years to pay off their debts. Others give consumers up to five years.

Depending on your credit score, you may also qualify for a dramatically lower interest rate through a personal loan than you would via a credit card. For example, some personal loan providers offer rates as low as 3.99%.

The terms on personal loans also tend to be easier to understand, Lewis-Parks said. “Most personal loans are very transparent about how much the person will end up paying for the loan,” she added.

That alone can be a big selling point for consumers who need more predictability or who worry that their debt will grow faster than they expected.

Don’t forget to look at the overall costs of a personal loan, though, when you’re considering your options. For example, some lenders charge origination fees ranging from 1% to 6%. Others don’t charge any origination fees.

Why a credit card?

Credit cards are a good option for consumers who can either afford to pay off their balances in full (and reap the benefits of rewards cards) or have a small enough amount of debt that they can pay it all off in just a year or two.

According to Beverly Harzog, a credit card and consumer finance expert for U.S. News & World Report, an interest-free balance transfer credit card can give you anywhere from 12 to 21 months to pay off a balance without incurring any interest. But you typically need a good credit score to qualify. That way, you can eliminate your debt — or at least shrink it — without paying a whole lot extra.

Some credit cards will even let you transfer a balance without paying a balance transfer fee after being approved, giving you the chance to pay off your debt for free.

Costs vary widely for balance transfer cards, though, so you’ll want to compare your options carefully. For example, some waive balance transfer fees, but only if you transfer your debt within a certain time frame. Others charge transfer fees as high as 5%.

When a personal loan may be a better option than credit

Despite their appeal, interest-free credit cards aren’t always the best or cheapest option, Harzog said. For example, if you have more debt than you can afford to repay within the card’s promotional period, you’ll have to pay much higher interest on the remaining balance. Many of the most generous balance transfer cards charge standard rates well above 16%.

Rates that high can add up quickly if you carry a large balance for longer than a couple of months.

“Let’s say you’re looking at several years to pay this off,” Harzog said. “Even if you have a high credit score and can qualify for the best balance transfer card, you might still want to go ahead and get a personal loan. With credit cards, I usually recommend those for a short-term situation.”

Lewis-Parks recommends giving yourself at least a one-month buffer when you estimate how much time it will take you to pay off a balance interest-free. For example, if you’re looking at a balance transfer card that gives you 15 months to carry an interest-free balance, divide your total debts by 14 months, rather than 15, to get a sense of how much you’ll need to pay each month.

Consolidating your credit card debt via a personal loan may also improve your credit score, Lewis-Parks said. Having a wider variety of loan types included on your credit report can boost your score.

Some personal loan lenders, such as Earnest and SoFi, take a more holistic approach to underwriting and consider a wider range of factors than traditional lenders, such as your career trajectory and spending history.

As a result, you may even qualify for a much lower rate loan than you would from a traditional credit card. That’s especially true if you’re inexperienced with credit but have a solid income and spending habits.

Looking for more alternatives?

There are other ways to consolidate your debt or pay for a big expense that may be a better fit, depending on your situation. For example, alternatives include:

  • Home equity loan: If you own a home that’s worth more than what you paid for it, you may be able to borrow against the value of your home by taking out a low-rate home equity loan or home equity line of credit, using your home to secure the debt. Beware, though: If the value of your home drops dramatically, you could wind up owing more than your house is worth.
  • Payday alternative loans: If you have damaged credit but know better than to seek a high-cost payday loan, you may want to check with your local credit union to see if it can help. Some credit unions offer small, short-term loans to members who might otherwise be at risk of taking out a payday loan.
  • Debt management plan: Debt management plans can be a good option for consolidating your debt if you’re paying extremely high interest rates and can’t qualify for cheaper loans. In this case, you’ll work with a credit counseling agency and your creditor to potentially lower your rates and reduce your monthly payments so that you don’t fall behind even further. Just be sure to research any credit counseling agency with which you work, Lewis-Parks said, and check their Better Business Bureau ratings. She also recommends only working with nonprofits.

Managing debt responsibly

Once you’ve set a plan in motion for paying down your debt, think carefully about how you got into debt in the first place, Harzog said.

“Figure out what got you into trouble this time and what you can change so that it doesn’t happen again,” she said.

Going forward, try to pay off your credit cards in full if you can afford it or limit your balances so that they don’t get out of control. Also be picky about the type of debt you take on and the lenders with which you work. Avoid high-interest payday loans and unscrupulous lenders that charge excessive fees.

If you think you’ll need to carry a balance on a credit card in the future, compare credit cards that offer the lowest rates — and don’t forget to look beyond the biggest lenders. Credit unions, for example, can offer some great deals on low-rate cards.


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