Last Updated: February 2, 2023
A personal loan is a lump sum of money in the form of credit from a traditional bank, online lender, or a credit union that you pay back in monthly installments with lower interest rates. The answer to the recurring question, “Is it worth it to get a personal loan to pay off debt?” is a definite “yes.”
That said, you might as well consider alternatives to borrowing a personal loan, such as taking out other loan types or seeking advice from a financial counselor.
This guide will have all of that explained focusing on the following aspects:
- Personal loans vs credit card loans
- Types of personal loans
- Pros and cons of getting personal loans to consolidate debts
- How to choose the best personal loan
- Alternatives to personal loans
Personal Loan vs Credit Card Loan: What’s the Difference?
Before further explaining the two “financial saviors” and making the personal loan vs credit card loan distinction, we must emphasize that both require disciplined monthly payments until the debt is finally paid off.
The process is more comfortable with repaying the personal loan because the installments are fixed, and they come at a variable or fixed interest rate depending on the plan for which you’ve signed up.
Personal loans provide you with an amount of money that is subject to being repaid monthly, usually from 36 to 84 months. The terms’ duration depends on what is being financed, and they may be even shorter than 36 months. During that time, you pay back the loan’s entire principal and interest in equal monthly increments.
On the other hand, credit cards offer you a credit line and a revolving balance based on how much your outstanding balance is at a certain period, i.e., as long as your account remains in good standing. You can repay your debt without interest during your credit-free period (within 18-50 days from the moment it was incurred).
Otherwise, the credit card debt transfers from one month to another. You are allowed to deposit minimum monthly payments as long as they are within the issuer’s minimum with a high-interest rate. You’ll always be poised to start spending money again and be burdened with a new debt because you still have access to your repaid funds.
Remember that your credit portfolio can be the determining factor of whether a personal loan or a credit card loan will be approved.
Types of Personal Loans
There is no one-size-fits-all loan type. Look into the following types of highly demanded personal loans before setting off on your journey to find the best kind of loan that matches your needs.
Unsecured personal loans usually have no collateral to guarantee their repayment. However, making late payments or defaulting on your personal loan has an adverse effect on your credit score because you have no property to take the hit. These loans come with lower interest rates and are usually approved for those with a solid credit score (somewhere between 670 and 740).
Even if your credit portfolio isn’t immaculate, you can still qualify for a secured loan. When applying for a secured personal loan, you have to provide an asset in the form of real estate, a vehicle, or savings account to guarantee that you will repay the loan. Otherwise, the lender can repossess the asset, providing that you don’t pay it back in full.
Debt Consolidation Loans
If you’re seeking help with debt consolidation and are currently paying off multiple debts at various rates, give debt consolidation loans a go. Loans of this kind come at fixed, lower interest rates than the existing loans and save you money, although it may take you slightly longer to pay them off.
A co-signed loan is a type of joint credit where a co-signer signs a loan, and the borrower guarantees its payback. If your score is low, the best personal loan advice is to apply for a consigned loan because the issuer evaluates both the co-signer and the borrower’s credit history in the process. This way, you stand a better chance of getting the loan even with a higher principal.
Lines of Credit
The line of credit is the preset loan amount available on their credit cards that the borrowers don’t have to use all at once, unlike the personal loan. They can access it at any time provided that their account balance is within the approved credit limit. You can pay off minimum amounts with a higher interest rate and re-borrow the funds infinitely.
Pros and Cons of Getting a Personal Loan to Consolidate Debts
- Lower interest rates (monthly or APR) – Your interest rate is usually lower than other kinds of debt, meaning you save on paying interest rates overall.
- Consolidated payments – Your worries about making a timely payment on every loan every month are now in the past because you only make a single fixed payment.
- Defined debt-free date – You have your installments precisely calculated, and you have a set timeline to get out of debt completely.
- Payment of multiple debts simultaneously – By getting a personal loan to pay off your debt, you cover the previous ones and only focus on paying back a single one.
- Higher amounts borrowed – You will be able to borrow more money than when using your credit card.
- Improved credit score – Your creditworthiness will improve once you pay the balance you owe and start making timely payments on your new loan.
- May turn out more expensive – Prepayment penalties may apply for paying off your existing loans earlier as well as application and origination fees for your newly issued loan.
- It is still another debt – Irrespective of the type of loan, you still need to pay it back unless you want a smudged credit portfolio.
- There are still interest rates included – Personal loan rates are lower, but if there are too many installments, you can pay more than if you haven’t consolidated.
- Some banks don’t lend money below a certain threshold – So you may end up borrowing more than necessary or more than you can afford.
How to Choose the Best Personal Loan
It’s paramount that you understand some financial terms related to loans before diving into the sea of financial institutions that offer various types of personal loans.
- Interest Rate – The annual cost of borrowing the principal of a loan.
- APR – The annual cost of borrowing the principal of a loan plus fees.
- Terms – Length of time it takes for a loan to be paid off.
- Fixed Interest Rate – An interest rate that won’t change for the whole duration of the term.
- Variable Interest Rate – Interest rate subject to change in response to market changes
- Loan Amount – The amount that the borrower agrees to pay.
- Repayment Period – The period between the first payment and its maturity.
- Refinancing – Replacing an existing loan with a new loan to pay off the former one.
- Collateral – Something of value offered to the lender as security for granted loan.
If you’re still wondering, “is it worth it to get a personal loan to pay off debt?” you need to consider several fees first. Once you do that, calculate whether you can handle the costs related to closing your debts prematurely and taking out a new, higher loan amount.
- Application Fee – Fee paid when submitting your loan application with individual banks, but you don’t necessarily decide to take the loan.
- Origination Fee – Fee charged when the loan is approved and charged as a percentage of the borrowed amount.
- Prepayment Fee – Fee charged if you pay back the whole borrowed amount before it’s due (being one of the debt consolidation options) and usually amounts from 2-5% of the amount.
- Late Payment Fee – Fee charged when you fail to make timely payment and ranges from $25-$50 if they’re flat fees and 3%-5% if they are percentage-based.
- Returned Check Fee – Fee charged for the costs incurred by processing an invalid check that you sent to cover a monthly installment, typically ranging from $20-$50.
When you’re thinking about getting a personal loan to pay off your credit card debt, think about your creditworthiness. If your credit score is low, look for the trustworthy personal loans for bad credit.
Compare multiple lenders who charge the lowest loan fees possible and who, most ideally, charge no application or origination fees. Sometimes lenders charge lower prices on account of higher interest rates, so you need to do the math and choose from the personal loan options.
In other words, sometimes paying fees for an installment loan with a long repayment period can yield a lower APR. However, before you start the loan application procedure, ask the lender for a quote.
Once you’ve weighed the pros and cons of personal loans to pay off your credit card debt and decided to take out one, you need to commit yourself to manage it responsibly.
Other Ways to Pay Off Debt
There are several alternative ways to eliminate your debt once and for all.
Credit Card Balance Transfer
Some credit cards allow you to transfer outstanding balances from another credit card and charge 0% introductory rates, but you may need to pay a small fee to transfer the balance. Once the 0% promotional period is over, but you still haven’t paid off your balance, high credit card interest rates will be charged.
In the personal loan vs balance transfer cards comparison, there is virtually no winner because you stay disciplined in paying off your debt with the former, but you save money on interest with the latter.
The debt snowball method involves paying off your debts, starting in order from the one with the lowest balance to the highest. You make the minimum payments on the other accounts and pay as much money as possible into the account with the lowest balance. You continue this trend until you pay it off entirely and start funneling money into the next smallest balance. Thus, taking a personal loan to consolidate debts is undoubtedly dispensable.
Paying off your debt by using the debt avalanche method means that you start paying back the loans in order from the one with the highest to the one with the lowest interest rate, i.e., paying as much extra money as possible into the account with the highest interest rate.
Once you entirely pay off the loan in focus, you make such “payment avalanches” into the account with the second-highest interest. At the same time, you need to make minimum payments in the other accounts.
Home Equity Loan
A home equity loan functions as a second mortgage, and you can borrow a substantial amount of money based on the equity you’ve built in your home and your financial standing. The collateral that guarantees your repayment is your home, so how hard it is to get a personal loan means nothing compared to the high stake in case of defaulting on it. The average home equity loan rates are usually lower than the regular personal loans, with the average rate amounting to 5.75% as of February 2021.
Retirement Plan Loan
Qualified plans (401(k) or 403(b) allow you to take a loan from your retirement assets and pay it back with interest into your retirement account within 5 years unless the reason you’ve taken the loan is to buy a primary residence.
The maximum borrowed amount is usually 50% of your vested balance. It is a viable way to tackle large-balance credit card debts with high interest. Yet, keep in mind, that it is a high-risk personal loan with a massive effect on credit score unless repaid sensibly.
Cash-Out Auto Refinance
Cash-out refinance replaces your current loan with a larger loan at a lower interest rate from another lender. The amount covers your original debt, which probably has a higher interest rate than the new loan, while you get the difference between the two back deposited into your account. You can then use this pocketed difference in various ways, including debt consolidation.
Credit counseling companies offer debt management advice, and to do so optimally, they must know personal loan information, although they don’t force you to provide it. They also offer a debt management plan (DMP) that you can sign up for if you’re puzzled about how to consolidate a credit card debt.
You make a single payment to the company that divides the amount among your creditors and negotiates lower interests and fees on your behalf. A set-up fee and a monthly fee apply for this service.
Canceling a Credit Card Account
When it incurs unnecessary costs, canceling a credit card is desirable, particularly when you pay an annual fee on a card that you don’t use. Another reason for doing so is your inability to harness your spending.
If you’ve calculated that the credit card interest vs personal loan interest is drastically higher, you may decide to take a personal loan for extra spending. However, make sure you settle your remaining balance before closing it down, as it will smudge your creditworthiness.
Debts can wreak havoc in your life if you cannot make steady monthly payments. So, is it worth it to get a personal loan to pay off debt? Probably yes. Rather than making multiple payments with oppressive high interest rates, consider taking out a personal loan to consolidate your debt and make debt repayment easier and cheaper.
A credit card is a line of credit from which you can borrow up to your credit limit at any given time. It is also known as revolving credit, where you can transfer your balance into the following month. One of the balance transfer benefits is the possibility of paying back a certain amount every month, including interest, depending on your revolving debt.
In theory, personal loans are a fantastic way to wipe out a consolidated debt and reduce the total interest rate paid on each. Paying off small debts one at a time can be more satisfactory for the borrower, and holding on for ample time to tackle a debt can be demoralizing. Consequently, they may give up on making payments and start spending again.
You can use the loaned funds for a wide range of purposes such as scholarship fees, holiday making, home redecoration, big purchases, medical costs, and whatnot. Personal loans are a golden solution for consolidating debts with high-interest rates and improving your credit score at the same time.
Paying off a loan with another loan makes sense, provided that the existing loan has a significantly higher interest rate than the new one and a shorter repayment period that your budget can’t handle. In other words, the newly originated loan must have better repayment conditions and possibly a more extended repayment period with a low APR.
What makes the personal loan a better option for covering your credit card debts is that you make a fixed loan payment every month with no flexibility to pay less, which is the case with credit cards. Your revolving credit card debt will allow you to make small, variable payments dictated by your budget. So, is it worth it to get a personal loan to pay off the debt in this case? Most likely.