Personal Finance

A Personal Loan Can Lift the Weight of Credit Card Debt

Nov 12, 2019

The proliferation of credit cards in today's society adds convenience to many of our daily lives. However, this readily available access to credit can come at a cost for those of us who are carrying hefty balances from one month to the next. Whether our credit card debt resulted from a financial emergency, a lack of restraint, or as a means to obtain reward points, we can find ourselves straining under the weight of high balances paired with high interest rates. Luckily, if you are one of these credit card users, there are a number of methods to help lighten the load. Let's look at some popular strategies you could use to reduce your credit card debt, if not eliminate it entirely.

Avalanche vs Snowball Strategies

The avalanche and snowball methods are two well-known strategies for paying off debt. The avalanche strategy involves paying off the credit card with the highest interest rate first. A large payment is made to the credit card with the highest interest rate and minimum payments are made to all the other credit cards. By paying off the balances at the highest interest rate first, you will generally pay less in interest overall.

In contrast, the snowball strategy involves paying off the smallest debt first and building momentum as each debt is retired. If you have many small debts, the number of statements you receive each month may seem overwhelming. The snowball strategy allows you to dispose of a number of individual debts quickly.

The Personal Loan Strategy

A personal loan can offer some of the same benefits as the avalanche and snowball strategies. Consolidating your debt into a single personal loan can combine the savings of a lower interest rate with the convenience of a single payment each month.

Banks, credit unions, and other lenders offer personal loans with fixed monthly payment amounts for specific periods. In many cases, collateral is not required, and the money from the loan can be used for whatever you want, including paying off high-interest credit cards. If you have a good credit history and debt of $5,000 or more, a personal loan may be a good option. Let's explore some of the benefits of this strategy.

Lower Interest Rate

With a personal loan, like the avalanche method, the goal is to carry your debt at the lowest interest rate available until you pay it off. To achieve this benefit, the interest rate on your personal loan needs to be lower than the majority of your credit card debt. With credit card interest rates going well beyond 20% for many borrowers, moving this debt to a lower interest rate can offer significant savings. The interest rate available to you will primarily depend on your credit score. The higher your score, the better. For example, a credit score of 780 might qualify you for one of the lowest rates, while a lower credit score might result in a higher interest rate.

When reviewing lender offers, ask about any origination or similar fees associated with the loan, including prepayment penalties. Origination fees can vary depending on your credit score, and not all lenders require them. Any fees you pay will affect the overall cost of your loan. Comparing the annual percentage rate (APR), which includes all fees associated with the loan, allows you to see the true cost of each loan offer.

Convenience of One Payment

Another benefit of consolidating multiple debts into a personal loan is that you can make a single payment instead of many payments throughout the month. Keeping track of one payment versus many due at different times can be much easier. It can also be motivating to see a sizable reduction in your balance with each payment.

In addition, your personal loan payment will be a fixed amount at a fixed interest rate. Unlike a credit card, you won't be surprised by an increased interest rate resulting in a higher minimum monthly payment.

Possible Lower Payment

Your monthly payment on a personal loan could also be less than the combined minimum payments to your credit cards. This is often the result of the lower interest rate on the personal loan. You can use the money from this difference in payments to avoid taking on new debt, save toward a major purchase, or create an emergency fund.

In some cases, your monthly loan payment could be higher than the combined minimum payments on your credit cards. A higher loan payment could help you retire the debt faster and result in your paying less interest overall. It's important to select a loan payment amount that works with your budget and matches your goals. You never want your loan payment amount to create a cash flow problem that could result in a late payment.

A Set Payoff Date

When you make the minimum monthly payment each month, you often don't see a noticeable reduction in your credit card balances. Because the minimum payment on most credit cards is a percentage of your current balance, as your balance goes down, so does your minimum payment amount. Also, your minimum payment is often around 1 percent of your balance plus interest. When you pay so little each month, it's hard to pay off the debt quickly. On the other hand, a personal loan has a set loan term and a set payment amount. You know when your debt will be retired, and it's a goal you can work toward every month.

Because a personal loan has a set term, you know the exact date your debt will be paid off.

How to Get a Personal Loan

The process to get a personal loan is generally simple. Most lenders ask you to complete an easy online application. Using the basic information you provide, the lender will pre-qualify you for a loan and send you an offer. If you decide to accept the lender's offer, the lender will then verify the information you provide before issuing a final loan approval.

Pre-Qualifying For a Loan

In most cases, completing an online application to pre-qualify for a loan will be your first step. In addition to your name and contact information, you may be asked to provide your date of birth, Social Security number, income, monthly obligations, and employer information. Once the lender has your basic information, they will perform a soft credit check. This will not affect your credit score, but it does allow the lender to provide you with a loan offer. When reviewing offers, look at the loan amount, monthly payment amount, term, and interest rate to find the loan that works best for you. You will want to read the loan terms carefully. Prepayment penalties and processing fees can add to the cost of your loan. Comparing the annual percentage rate (APR) of each offer is helpful because it factors in the fees associated with the loan along with the interest rate.

Final Approval

After you settle on the offer you want, you will need to provide some additional documents to verify your information before you get a final loan approval. This may include documents related to your income, identification, and address. For example, a copy of your driver's license or state ID may be used to verify your identity. A W-2 form and paystubs can be used to document your income. If your loan is approved after a review of your documents, the lender may run a hard credit check with one or more of the credit agencies. The last step in the process is the funding of your loan. How quickly you receive your money depends on the lender. Some are able to forward it to you within one to two days of your acceptance of the final loan offer.

Avoiding a Reoccurrence

After working so hard to pay off your debt, you may be determined to avoid a repeat of the situation. If so, it may be helpful to identify how you acquired the debt. If it was the result of a major expense, you may want to make regular deposits to a savings account to create an emergency fund. If you developed some poor spending patterns over time, you could benefit from setting up a monthly budget plan. Regardless of the reason for your high-interest debt, the ultimate goal is to establish healthy financial habits that will help you avoid a reoccurrence in the future.

Credit Card Strategies

Closing all your credit card accounts after you pay off the balances may be an option you are considering. After all, it would remove the temptation to charge again. On the other hand, closing your accounts could hurt your credit score because having active credit cards helps to document your ability to manage revolving debt. There isn't one option suitable for everyone. It varies by individual. The websites for the Federal Trade Commission and Consumer Financial Protection Bureau can provide guidance in this area. Also, the websites for Experian, Transunion, and Equifax offer information regarding how closing credit card accounts can affect your credit score.

Whether to keep or close your credit card accounts after you pay off the balances depends on your unique situation.

When your credit card balances are not going down fast enough, a personal loan could help you save money on interest and retire your credit card debt faster. Trading your credit card debt for a personal loan could result in additional benefits, such as a lower interest rate, the convenience of a single payment, possibly a lower monthly payment, and a set payoff date. With many lenders offering an easy online application process, it's not complicated to find out whether a personal loan is the best solution to your high-interest debt.

You can learn more about the specific features and benefits available with an Axos Bank personal loan and quickly complete an online application for your personalized offer.