How to Use a Personal Loan to Pay Off Debt
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Uncontrollable debt can strain your budget and leave you with little money after paying your monthly bills. If you manage multiple balances, a personal loan can be a valuable tool to help pay off your debt.
Consolidating high-interest debt with a personal loan can help you save money on interest and simplify your finances since you only have one payment to follow. Understand how personal loans can help you decide if it’s a good idea to use one to consolidate your debt.
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What is debt consolidation?
Debt consolidation consolidates several debts into a single personal loan or credit card. Depending on your credit, you could pay less interest and lower your monthly payments while making it easier to manage your debt.
Generally, a debt consolidation loan is an installment loan with a fixed interest rate and a monthly payment. Most personal loans are unsecured, so you won’t have to provide collateral. Your eligibility will depend on your credit history, income, and debt-to-equity ratio, among other factors.
To save money, you should only consider taking out a personal loan if the interest rate is lower than the rates on your existing debts.
You can take out a personal loan through a bank, credit union or online lender. When you apply to an online lender, they streamline the loan process so you can receive funds quickly, often the same or next business day. Loan amounts vary by lender, but generally range from $1,000 to $100,000.
When you apply for a personal loan, the lender may ask you to specify what you plan to do with the loan funds. Most lenders allow you to use a personal loan to consolidate your debts, but it is essential that you understand the terms of the loan, as some lenders may restrict how you can use the money.
If the lender approves your personal loan, financing is usually done in two ways if you are using the loan for debt consolidation:
- Lump sum payment — You will receive a lump sum as a direct deposit into your bank account which you can use as needed. You can then use the funds to pay off all your existing debts.
- The lender pays your creditors — Some lenders send direct payments to your creditors on your behalf.
If you are repaying the debts yourself, submit the repayment amount, not the minimum amount due or the statement amount. You will want to make sure that you bring your balance down to zero. You will then begin to repay the new personal loan with a fixed monthly payment.
Visit Credible for compare personal loan rates from various lenders, without affecting your credit.
Advantages of taking out a personal loan for debt consolidation
Here are some benefits of using a personal loan to reduce your debt:
- Potentially save money — With good credit, you may qualify for a personal loan with lower interest rate than what you pay on your credit card debt. The average interest rate on a 24-month personal loan in May 2022 was 8.73%, according to data from the Federal Reserve. This is significantly less than the average interest rate of 16.65% for credit cards during the same period.
- Can pay off debt sooner — Depending on how much you owe, it could take years or even decades to pay off your card balance. But personal loans have fixed repayment terms with a specific repayment date, so you’ll know exactly when your balance will hit zero.
- Simplify your payments — Managing your debt is much easier when you only have one payment to make rather than trying to meet multiple deadlines for all of your accounts.
Disadvantages of taking out a personal loan for debt consolidation
As with any credit product, it’s wise to consider its downsides before making a decision. Personal loans have a few disadvantages, including:
- May not qualify for a lower interest rate — Although personal loans generally offer lower interest rates than credit cards, you may not receive a lower interest rate if you have bad credit.
- Come with fee — Check the terms of your loan for fees that could reduce your savings due to a lower interest rate. Additional charges may include loan origination fees, late payments, and insufficient funds.
- Potential for more debt — Debt consolidation can provide long-term benefits to your finances by paying off multiple credit card and other debt accounts. But if you rack up debt on those accounts again, you could end up with more than your original debt.
Other debt repayment strategies to consider
If a personal loan isn’t right for you, you can still pay off your loan principal faster—and save on interest charges—by making more than the minimum payments in your accounts. Also consider using these other debt repayment strategies:
- Debt Avalanche Method — The debt avalanche strategy focuses on paying off debt accounts with the highest interest rates first. By prioritizing your payments to eliminate high-interest debt first, you could save more in interest.
- Debt Snowball Method — This strategy involves paying off credit accounts with the lowest balances first to enjoy quick wins that build momentum and motivation.
- 0% APR Balance Transfer Card — Transferring your debt to a balance transfer credit card with a 0% APR introductory period between six and 21 months is an effective way to pay off debt. Without the interest charges dragging you down, all of your payments during the promotional period will go directly to paying off your debt, minus the fees. Remember that if you still have a balance at the end of the promotional period, you will start earning interest at the card’s regular rate, which may be higher than a personal loan.
Whether it’s through a debt consolidation loan, a repayment strategy, or a balance transfer credit card, getting rid of your debt has its benefits. Living debt-free can leave you with less stress, more freedom, and the ability to focus more on savings and wealth.
If you want to apply for a debt consolidation loan, Credible allows you to quickly and easily compare personal loan rates to find one that meets your needs.