America has reached $1 trillion in total revolving credit in the year 2018, according to the Federal Reserve. It means a hefty monthly financial obligation that could weigh down your budget for months, years, and even decades.
If you will not act now, you might be stuck in an endless debt cycle.
But to get out of your debt, is it wise to use a personal loan? The answer depends on several factors. Are you qualified for a low-interest rate? Or do other alternatives work better for you? To guide you in making a wise decision, let me discuss the pros and cons of using a personal loan to pay off debt.
Pros of Using Personal Loan
One of the pros of using a personal loan to consolidate your loan is that it simplifies your life. Instead of tracking the number of payments every month, you only need to pay one balance. Having a lot of different cards to pay might confuse you and might tend to miss paying them.
And missed payments mean late fees.
Another pro is the lower interest rate. Though there is no guarantee, you are likely to secure a lower interest rate than what you are paying for your credit card. Your interest rate is dictated by several factors – credit score, debt-to-income ratio, credit history, and employment status. If you have a low debt-to-income ratio and a good credit score, you are likely to get a more competitive interest rate.
A low-interest rate could mean low monthly payments. It could save you money and could have extra room for your budget.
If you are planning to pay your loan in advance, be wary of the prepayment penalties. If your lender does not have prepayment penalties, paying it in advance could save you more money.
If you can qualify for a low-interest loan, it is wise to consider a personal loan to consolidate your debt. It would be cheaper, more convenient and you are likely to pay off your debt fast.
It might take you decades to pay off your credit card if you only are making minimum payments.
But with debt consolidation loans which have a term of usually 24-60 months, you can pay off your debt in just a fraction of time.AQ
Lastly, a personal loan could help you improve your credit score.
How? If your credit profile is consumed by revolving credits, diversifying it with a personal loan can give a boost to your credit score. Make sure not to miss your payment and manage your debt responsibly. Though it may not immediately reflect your credit score, it’s a good step in building good credit.
Cons of Using Personal Loan
Lenders have different borrowing criteria for a personal loan. Some lenders do not just issue personal loans to anyone. Some of the factors that they look into are your employment status, credit history, and debt-to-income ratio.
Most lenders require a minimum credit score of 525 to qualify someone for a loan. Though some lenders approve loans for people with bad credit, you need to be cautious with the interest rate. If the interest rate is higher than what you are paying for your credit, look for another lender, or consider other alternatives.
Also, be mindful of the fees that come with your loan. Some lenders charge an origination fee that could vary from 1% to 6% of the total loan amount. Say, if you are approved for a $6,000 loan with a 2% origination fee, you have to pay $120 upfront.
In this case, it could be possible that a personal loan can be more expensive than your credit card. Make sure to do your calculation.
Factors to Consider in Choosing a Personal Loan
Do not agree on the first lender that you see on the internet. Shop for other lenders and compare their offers. Below are the factors that you need to take into account:
- Annual Percentage Rate: In most cases, personal loans could have an APR of as low as 3.49%. Make sure to work with lenders with this rate or lower as APR has a direct impact on your monthly payment.
- Term of the loan: In most cases, personal loans come with a term length of 24-60 months.
- Other Fees: It is also important to note the other fees involved in your loans such as origination fees and prepayment penalties as it could make your loan more expensive.
- Amount of the Loan: The amount that a lender can loan you may vary from $1,000 to $50,000 but take that not all lenders can approve you in the amount that you need. Make sure to work with one lender who can loan you the total amount that you need.
If you find a personal loan more expensive than your existing debt, consider these three alternatives – balance transfer credit card, home equity line of credit, and borrowing from peers or family members.
Your goal is to pay off your debt faster and cheaper. After weighing the pros and cons and you find personal loans to be a better option for you, make sure not to fall into the debt trap again. Keep your eye on your goal and make sure not to miss your payments.