Taking control of credit card debt is a key step in becoming financially fit. As more people consider refinancing their credit card debt into a personal loan to pay the debt off once and for all, it’s helpful to review these do’s and don’ts.
- understand the base premise
- evaluate the benefit in lower interest rates
- consider a personal loan if your credit score does not reflect your repayment capabilities
- be prepared to be open and honest about your finances
- use a budget
- turn to a personal loan if it will take less than a year to pay off your debt
- turn to a personal loan if you are unable to make minimum payments on current debt
- pursue a personal loan unless you are disciplined
- look at a personal loan as an alternative to an emergency fund
- view a personal loan as a license to keep racking up credit card debt
A number of private companies are emerging to offer personal loans as a means of refinancing credit card debt into a fixed, amortizing installment loan. These loans can be helpful tools for many consumers using them to help pay off credit card debt.
These loans can provide lower rates than many credit cards, but the rates are not exceptionally low. Where credit cards can carry interest rates of 15-25 percent, a personal debt refinance loan can lower that rate by 2 to 4 points. For example, if you repaid $10,000 over 60 months at a 20 percent interest rate, you would pay $265 per month. The interest fees you paid would total $5,894. If you could lower the interest rate to 16 percent with a personal loan, over the same 60-month period, you would pay $243 a month and save more than $1,300 in interest expense.
With tightened lending requirements of many banks and credit unions, it can be hard for some people to obtain traditional loans. The new independent lenders, often known as peer-to-peer lenders (FreedomPlus, Prosper, Lending Club), use different criteria than a traditional bank or credit union to evaluate how likely a person is to repay a loan.
Personal loan lenders often will want to have a direct conversation with you to learn about credit scores and profiles, savings, life insurance, and other factors that indicate your level of financial responsibility. They may request documentation to substantiate the information you provide.
Incorporate loan payments, and all other expenses, into a simple budget to make sure you are able to make required payments in full and on time. Use a computer program (many available free online), a spreadsheet, or pencil and paper.
These loans typically charge an origination fee of 1 to 5 percent of the loan amount. For someone who can pay off their debt within a year, it generally is not cost-effective to use a personal loan to do so.
At that point, it is smarter to look into other help, such as debt settlement or credit counseling.
Most debt refinance loans are issued for a period of 36 to 60 months, and have strict monthly payments and timelines. If you don’t have the financial discipline required to meet these requirements, skip the personal loan.
Getting rid of credit card is, in and of itself, a helpful financial cushion. But no matter what, conventional wisdom is to save six-nine months’ worth of basic living expenses in an emergency fund. Start small and build it up gradually.
You must address the root cause of why you got into credit card debt in the first place. Remember that the goal is to live within (or, better, beneath) your means – which means only charging what you can pay off in full and on time every month. If you can not do so, you must find a way to reduce expenses or increase income.
Used the right way and in the right circumstance, personal loans can help some consumers eliminate their credit card debt once and for all. Use care in evaluating your situation, and in choosing a lender.