Are you drowning in credit card debt? If so, using a loan to pay off your balance could be the financial lifeline you need. That’s because a loan may lower your interest, simplify payments, and help alleviate your financial woes. Let’s take a closer look at when it might make sense to use a personal loan to pay off credit card debt.
Key Points:
- A personal loan can provide you with the funds needed to pay off all outstanding credit card balances.
- However, taking out a personal loan only makes sense if you can secure a lower rate on the loan compared to the rate you’re paying on your credit cards.
- Adding more debt to the pile should only be approached with care to avoid getting caught up in a never-ending cycle of debt.
Can You Use A Personal Loan To Pay Off Credit Card Debt?
Yes, you can use a personal loan to pay off credit card debt. This strategy — which can be considered debt consolidation — can simplify your payments and potentially lower your interest rate, helping you pay off your balance faster and save money over time.
This strategy only works if the interest rate you’re getting from the loan is lower than your credit card’s interest charges. In addition, you must resist the urge to take on additional debt.
| Do You Have Too Much Credit Card Debt? Whether you have excessive credit card debt depends on two key metrics: your debt-to-income ratio and credit utilization rate. If your monthly debt payments exceed 44% of your income, lenders may view you as a higher-risk borrower. And if your credit usage is well over 30% of your available credit limit, your credit score may suffer. If you think you’re carrying too much debt, consider cutting expenses, paying more than the minimum on your credit card, or using a balance transfer card to reduce interest. |
Benefits Of Using A Personal Loan To Pay Off Your Credit Card Balance
Using a personal loan to repay credit card debts has its advantages, both financial and non-financial. A list of the benefits can be found below.
- Lower Interest Rates: Certain loans — like personal loans and home equity loans — often have lower interest rates than credit cards. This can reduce the total amount you pay over time.
- Fixed Repayment Schedule: Unlike credit cards with revolving balances, loans have fixed monthly payments and a set repayment date. This can help you stay disciplined with your repayments. That said, some loans only require you to pay back the interest only, so read the fine print to ensure you’re maximizing your loan.
- Simplified Finances: Consolidating multiple credit card balances into one loan streamlines your payments, making it easier to manage your budget.
- Improved Credit Score: Paying off credit cards can lower your credit utilization ratio, which may boost your credit score over time.
Learn more: Pros And Cons Of A Personal Loan
Risks Of Using A Personal Loan To Pay Off Your Credit Card Balance
Be sure to weigh the potential risks of taking on more debt to repay your credit card balances, which may include the following:
- Higher Overall Costs: If the loan has a longer term or higher interest rate than your credit card, you could end up paying more over time.
- Risk Of Repeating Debt Cycles: Without changing spending habits, you might pay off your cards only to accumulate new balances. This can leave you with both loan and credit card debt.
- Impact On Credit Score: Applying for a loan triggers a hard credit inquiry, which may temporarily lower your score. Missing loan payments can also damage your credit.
- Secured Loan Risks: If you use a home equity loan or HELOC, your home serves as collateral, which means it’s at risk of repossession if you default.
| Pro Tip: Seek Out Credit Counselling Sometimes, the way to eliminate credit card debt is to receive personal finance education or advice. A credit counsellor can help you create a debt repayment strategy and help you develop habits to ensure you remain debt-free in the future. |
How To Use A Personal Loan To Pay Off Your Credit Card Debt
Using a loan to pay off credit card debt involves the following steps:
1. Apply For A Loan
Start by checking your eligibility. Lenders typically assess your credit score, income, and debt-to-income (DTI) ratio to determine your repayment ability.
Then, choose your loan term, which can vary significantly depending on the exact loan type you apply for.
- Shorter loan terms mean higher monthly payments, but you’ll be debt-free sooner.
- Longer terms can help your monthly payments fit in better with your budget, but you’ll pay much more in interest over the life of the loan.
2. Use The Loan Funds To Pay Off Credit Cards
Once approved for your loan, you can use the money to pay off your credit card debt. You’ll need to ensure that the loan amount you take out is enough to cover all your credit card debt. This consolidates your debt into one manageable loan.
3. Repay The Loan Over Time
Establish a monthly payment schedule that aligns with your loan term. A fixed repayment term helps build discipline and predictability, ensuring you stay on track and avoid revolving debt.
You’ll need to make consistent payments until the loan is fully repaid. Making timely payments can also help you build good credit, which can open more credit opportunities in the future.
| Can I Qualify For A Personal Loan With Bad Credit? Yes, you can still qualify for a personal loan with bad credit, but you may be charged higher interest rates than a credit card. This will make your loan very expensive, which may not be worth it. |
Things To Consider Before Using A Personal Loan To Pay Off Credit Card Debt
Taking out a personal loan to pay off credit card balances doesn’t eliminate your debt; instead, you’re simply moving money around, albeit to simplify things and ideally save money in the process. For this reason, it’s not always the right option to take out more debt to repay debt.
Make sure you carefully consider the following before taking out a loan to pay off your credit card debt:
Can You Qualify?
Consider the loan amount you need and the interest costs you can comfortably afford. Will the loan amount you can qualify for be enough to cover your credit card debt?
Further, what interest rate will you be offered on your personal loan? Will it be significantly higher than your credit card rate? If so, you may want to rethink this option.
Can You Afford The Monthly Payments?
Not only should you consider the overall cost of the loan, but you’ll also want to ensure that the monthly payments fit comfortably within your budget. Consider the loan term, which determines how long you have to spread out the loan, and ultimately impacts the payment amounts you’ll need to cover each month.
Will You Rack Up More Debt?
If you haven’t addressed the root cause of your credit card debt, like overspending, then a loan may only offer temporary relief. By taking on more debt, you risk running up new balances while still repaying the loan.
Is A Personal Loan The Best Option?
If your financial situation is particularly severe, a loan might not do much to avoid an inevitable need to file a consumer proposal or declare bankruptcy. In such cases, these debt relief options may be more appropriate.
Other Loans You Can Use To Pay Off Credit Card Debt
Several loan options are available to help you access the funds needed to repay your credit card debt:
Line Of Credit
A line of credit is a flexible loan that allows you to borrow up to a set limit as needed, rather than receiving a lump sum. You only pay interest on the amount you use, not the full credit limit.
Learn more: Best Line Of Credit Rates In Canada
Home Equity Loan
A home equity loan is a fixed-term loan that lets you borrow against the equity in your home. You receive a lump sum and repay it over time with a set interest rate and monthly payments. It typically offers lower rates than unsecured loans but uses your home as collateral.
HELOC
You can also use a home equity line of credit (HELOC) to pay off your credit card. A HELOC is a revolving credit line that’s backed by your home’s equity. It allows you to access as needed, up to a set limit, and repay over time.
HELOCs typically offer lower interest rates than credit cards but come with variable rates and the risk of foreclosure.
| Note: If you keep using your HELOC, your mortgage may end up exceeding what you originally borrowed. |
Best Ways To Pay Down Credit Card Debt
If you don’t think a personal loan is the right option for you to repay your credit card debt, you have other options. The route you take should be suitable for your personal financial position and goals.
- Snowball Repayment Method: Under this method, you would repay the smallest debts first, then work your way up to larger debts until you’re debt-free. So, if you have many credit cards with balances, focus on repaying the lowest balance first.
- Avalanche Repayment Method: With this strategy, you would repay debts with the highest rate first, while making minimum payments on all other balances. Then, you’d move on to the next-highest-interest debt, and so forth until all debt is eliminated.
- Budgeting: Debt can often be managed through a realistic budget. Write out all your income and expenses, then determine what you have leftover to put toward your credit card balance. You can also take the opportunity to reduce your expenses and earn extra income where possible, or use a budgeting app to make this process easier.
Bottom Line
Carrying credit card debt can be both financially and mentally burdensome. When considering taking out a loan to pay off your credit card balance, consider both your financial situation and how it could impact or even enhance your lifestyle. If using a loan to pay down your credit card balance helps you become debt-free in a manageable way, it’s an idea you may want to consider.
