Should I get a personal loan to pay off credit card debt?
I'm Doug Hoyes, a licensed insolvency trustee at Hoyes Michaelis Associates. Are you struggling with credit card debt and wondering if getting a personal loan to pay off your debt is a good idea? In this article, I'll explain the pros and cons of getting a loan to pay off credit card debt, and I'll give you some additional options to help you get out of debt sooner.
There is one obvious reason to get a debt consolidation loan to pay off a credit card. The interest rate may be lower. Let's say you owe money on a credit card and the interest rate is 20%. If your bank or credit union agrees to give you a loan where the interest rate is 10%, great, you use the proceeds from the loan to pay off your credit card and you just cut your interest rate in half.
Even better, if you keep your monthly payment the same, with the lower interest payments, more of your monthly payment goes to principal and you pay off your debt faster. Fantastic. Sounds great. What's the downside? Well, the first issue is that your monthly payment may not drop. Your credit card has a minimum monthly required payment, which might be 1 3 percent of your balance owing, plus any late fees and interest for the month.
So, if you owe 10, 000 on your credit card, and the interest rate is 20%, And you're required to pay 2 percent of the balance each month. Your minimum payment this month is around 367. If you get a 10, 000 loan at a 10 percent interest rate, and the bank says you gotta pay your loan off over two years, well, your monthly payment is around 460 a month.
Your monthly payment went up. That's hard on your cash flow. Now, if you can get a 10, 000 loan amortized over five years at 10%, your monthly payment is around 213 a month. So that does help your cash flow. And of course, with the consolidation loan, you pay a lot less, less interest over the life of the loan.
So it's a good idea. But here's my point. Read the fine print. Your monthly payment compared to what you're paying on your credit card may be higher or lower depending on the interest rate and the term of the loan. The second advantage of a fixed term loan is you'll know exactly what you'll be paying each month.
Unlike a credit card where the interest rate can change, and your payment can change, a fixed loan is fixed, so you'll know exactly what you'll have to pay for the life of the loan, so that makes budgeting a lot easier. And because the term is fixed, you know when you will be debt free. That's a great motivator.
So getting a loan to consolidate credit cards can be a good idea as long as the monthly payments fit within your budget and the interest rate is lower. Sounds great. What's the downside? Well, first, you may not qualify for a loan at a lower interest rate. Your bank might be happy to have you pay 20 percent interest on your credit card, but they may not be as happy with you only paying 10 percent interest on a loan.
If you don't have a great credit score, perhaps because of all your credit card debt, you may not qualify for a loan at a good rate. There's another issue. If you get the loan and pay off your credit card, but you don't cancel your credit card and you then run the risk of racking up your credit card again, and now you owe on your loan and your credit card.
That's not good. The bank may make you surrender your credit card, or perhaps they'll lower the authorized limit. which may be good for you. So here's my advice. If a personal loan seems like a good fit for you, consider your loan options. You can choose a term loan, installment loan, or a line of credit. If you own a home, you could apply for a loan secured by your home equity.
Second mortgage or home equity line of credit usually has a lower interest rate than an unsecured loan. Balanced transfer credit card deals may offer a low or 0 percent introductory interest rate, so they may be an option, but carefully review the introductory period's duration and any extra fees or penalties if you miss a payment.
I don't recommend payday loans, high interest bad credit installment loans, or car title loans to consolidate your debt because the costs are just too high. If you don't qualify or can't afford a personal loan, consider other debt solutions like a consumer proposal. I'll include a link to a video about these options in the notes below.
To learn more, visit hoist.com.
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