If you’re trying to manage some recently acquired credit card debt, you’ve come to the right place.
Credit card debt can set off all types of uncomfortable feelings but it’s undeniable that putting it on plastic is often the most convenient option—whether ‘it’ is an emergency, a vacation, a special event, or simply the often-expensive holiday season.
In many cases, it’s worth refinancing credit card debt into a personal loan. In plain English, that means taking out a lower-rate loan that you use to pay off your credit card all at once—and making subsequent payments to the lender rather than your credit card company.
This tactic doesn’t make sense for everybody, so we’ll help you understand when refinancing credit card debt is the best option (and when it’s not).
What You’re Up Against
Before diving into refinancing via a personal loan, let’s first understand why even a small amount of credit card debt can be so damaging to your long-term finances. Not only do credit cards have high rates, they also may have a variety of fees associated—whether that’s a late fee or an annual fee.
According to Bankrate, the average APR ranged from 12.56% to 18.49%, with the average variable rate at 16.43%, as of February 2017. If your rate is in this range, consider it high when compared to some of the other loan options available.
The majority of credit cards offered today operate as variable rate loans—that is, the interest rate you’re charged for any account balance is tied to the Federal Reserve’s prime rate. That’s fine in a low-interest rate environment, but with several rate hikes expected in 2017, those with credit card debt could soon be paying even more in interest.
Let’s look at an example to better understand how these numbers play out.
Perhaps you’ve racked up $5,000 on your card over the holidays and you’ve got wiggle room in your budget for monthly payments of about $150. On a credit card with 18% APR, it would take nearly four years to pay off that debt (assuming you’re not adding more to it), and your interest would total $1,984 over the repayment period.
Of course, the more you pay per month, the faster the debt will go away (and the less it will cost in interest). With a monthly payment of $500, for example, your debt will be gone in 11 months and interest will cost $458. (You can use this calculator to calculate how long it will take you to get debt free with your current credit card.)
Enter the Personal Loan
Taking out a new loan may seem daunting, but, in reality, using a credit card is essentially the equivalent of taking out a series of high-interest loans with every swipe.
While a personal loan doesn’t make sense for everyday purchases, it can be a great option for a financially responsible person with a chunk of credit card debt that was taken out for a specific purpose.
Taking the above example a step further, let’s say you refinance that $5,000 in credit card debt by taking out a personal loan. If you’re constrained to lower monthly payments, you’d be looking at a three-year repayment plan. Those with a great credit profile will be able to snag a rate as low as 6% for a three-year loan, which would put total interest costs at $463 over the life of the loan—remember, this is compared to nearly $2,000 in interest for the same balance on a credit card. Even with Earnest’s highest rate for a three-year loan of 12%, interest would total under $1,000 (more than half of what you’d owe to your credit card company).
If you’ve got more budget flexibility and monthly payments closer to $500 make sense for your situation, you’ll be able to take out a one-year loan. In this case, you’d pay around $150 in interest on the lower end (if you’re approved for a rate around 5-6%) and closer to $300 for a higher interest rate.
But personal loans aren’t just beneficial in terms of dollars saved. With a personal loan your rate is locked in the moment you sign the loan agreement, so you’ll know exactly what you’ll pay over the entire life of the loan. With a credit card, your payment could fluctuate if and when the Fed moves rates.
When a Personal Loan Isn’t Right
While refinancing credit card debt from a significant event or purchase can make sense for many people, there are certainly times that it doesn’t, including:
If you’re unsure whether you can commit to a set monthly payment. Unlike credit card payments, which can be made for any amount above your minimum, a personal loan locks in your interest rate by putting you on a set payment plan—for the same dollar amount each month.
If you have less-than-stellar credit, as this can make it hard to get approved for a loan. Even if you are approved, the rate for a borrower with poor credit will be toward the higher end, meaning you may not save any money.
If you’re using a personal loan so that you can continue to add additional purchases to your credit card. Consider a personal loan a one-time way of lowering your rate for a large sum that you’re planning to pay off.
If you’re planning to pay off your credit card debt soon, and in one lump sum in the near future—perhaps you’re waiting for a bonus or tax refund, for example. In this case, it’s probably not worth going through the application, approval, and signing process to get a loan that you’ll end up paying off shortly.
Paying off credit card debt with a personal loan isn’t for every situation, to be sure. But for financially responsible borrowers paying down debt from a one-time purchase, a loan can make a lot more sense — both financially and in terms of the peace of mind a locked-in payment plan can bring.