Hmm… a personal loan to pay off debt…is that a good idea or a bad one? Well, it all depends on your personal situation and what you do after you get the loan. I lay it all out for you, so read on.
Should You Use a Personal Loan to Pay Off Debt?
If you have outstanding small loans or lots of credit card debt you may have thought about using a personal loan to pay them off but then the question becomes is using a personal loan to pay off debt actually a good idea? The short answer is…it depends.
There are pros and cons when you use a personal loan to pay off debt, so let’s take a look at both sides.
Pros of Using a Personal Loan to Pay Off Debt
Lower Interest Rates –
One of the best reasons to get a personal loan is that the interest rates are typically much less than the interest rates on credit cards. Depending on your credit, you can be paying 19% or even 25% interest on a credit card. Even at 10%, it can take years to pay off your balance. This is especially true if you are paying the minimum balance each month.
Personal loans, on the other hand, typically have lower interest rates. Depending on your credit, you can get rates as low as 5%. This will make a huge difference in your monthly payment and in how fast you can pay off your debt.
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Consolidate Debt –
Another good reason to use a personal loan to pay off debt is that you can consolidate all of your credit cards and loans into one payment.
For example, if you are paying on three credit cards right now and a small loan, that means you have 4 minimum payments you have to make each month. To get any of them paid off, you’ll need to make more than the minimum payment, so you could be looking at $100’s of dollars a month in payments just to get anywhere.
If you use a personal loan to pay off debt, you will consolidate all of those payments into one monthly payment. This one payment will normally be lower than all of the payments you are currently making. That’s partly due to the lower interest rate.
No Collateral –
Unlike a loan, you get to buy a car or your home, personal loans do not require collateral. That means they are unsecured.
You don’t have to put up anything to secure the loan such as a car. Whether you are approved or not for the loan depends mostly on your credit rating.
If you have a fair to good credit rating, you can typically be approved for a personal loan. You don’t need perfect credit to get one.
Of course, your interest rate will be determined by your credit rating. That means the better credit you have the lower your interest rate will be.
Quick Turn Around Time –
Because personal loans are mostly unsecured loans and based on your credit score, you can fill out a quick application and get approved very quickly.
Sometimes, you can apply one day and have your money the next day. In addition, personal loans normally range from $5,000 to $35,000, so you can get the right loan for your personal situation.
Cons of Using a Personal Loan to Pay Off Debt
If you are considering getting a personal loan there are a couple of cons you need to be aware of before you sign on the bottom line.
Secured Personal Loans –
While most personal loans are unsecured, there are some types out there that require some sort of collateral. The most common are title loans. These are personal loans, but they are using your vehicle to secure the loan.
You never want to use this type of loan. The interest rates on these loans can be as high as 500%! These companies use loopholes in banking regulations to be able to charge these types of interest rates.
Studies show that up to 93% of people that get a title loan will lose their vehicle to the loan company. You don’t want this to happen to you.
In fact, if you ever apply for a personal loan and they want any kind of collateral whether it is your car, your paycheck, or something else, run as far and as fast as you can away from the loan.
If you don’t, you will find yourself in a vicious cycle of paying hundreds and thousands of dollars in interest for a very small loan, and you may lose your collateral.
Here are some personal loan options if you decide one is right for you:
- Smarter Loans
- Even Financial
Using Your Credit Cards –
If you decide to get a personal loan to pay off debt, especially credit card debt, you want to make sure you don’t keep using your credit cards. Too often, people will pay off the balances on their credit cards with a personal loan and then keep using the cards.
Before they know it, the balances are back up to where they were and now you have to pay the credit card payments each month as well as paying back your personal loan. This is a horrible trap to fall into.
Once you use the loan to pay off your credit cards, you want to keep them and don’t cancel them as that can hurt your overall credit score, but you want to put them away and not use them.
Hopefully, as part of paying off your debt you will have saved up an emergency fund, so you don’t have to use your credit cards for emergencies, but if not, now is the time to do so.
When handled the right way, personal loans can be a great way to pay off debt that has a high-interest rate. You just want to keep from falling into the traps of secured personal loans and using your credit cards.