Borrowing to pay off credit card debt might seem like a case of robbing Peter to pay Paul. However, this really can be a viable means of eradicating a significant amount of debt in a more expedient fashion.
Also known as debt consolidation, this strategy can lower your interest payments, give you far fewer bills with which to deal each month and help you pay off your credit card debt faster.
The key is finding the best method for your circumstances.
How Debt Consolidation Works
There are three main types of loans people use to accomplish this — personal loans, balance transfer credit cards and home equity loans/lines of credit. Each of these methods has advantages and disadvantages, as we will briefly expound upon below.
Essentially though, you’ll accept a loan from a financial institution of an amount capable of paying off most or all of your credit card debt. The funds from this loan will go to your creditors and you’ll then make payments to the lender with which you did the consolidation.
As previously stated, this has the potential to lessen the amount of interest you’ll pay in aggregate. It can also shorten the amount of time you’d need to pay off all of those cards individually, the potential result being faster eradication of debt at less cost.
Still though, if you’re wondering is debt consolidation a good idea, the answer is — it depends.
Personal Loans can be quite effective when used for debt consolidation, which is the use to which most personal loans are put. The big advantage of unsecured personal loans for this purpose is they are secured only by your promise to pay. In other words, you don’t need to offer collateral to get one. On the other hand though, you do need really good credit and a solid income to make this tactic worth pursuing.
Remember, the goal of consolidation is to lessen your interest payments and shorten the amount of time required to pay off the loan. This means you’ll need to get the best possible interest rate.
Your credit score will need to be 690 or better to make that happen. Otherwise, you’ll likely find this approach too expensive to make a difference. The key here is to get a handle on the average interest rate you’re paying on your credit cards, then compare it to the best rate you can get on a personal loan.
Balance Transfer Credit Cards, while they might not seem like borrowing per se, that’s exactly what they are. The card issuer loans you the money to make a purchase and you agree to repay it within set amount of time with no interest. If you don’t pay within that “grace period” interest is applied to the amount you borrowed.
Balance transfers work in a similar fashion, except the card issuer loans you money to pay off other credit cards — effectively transferring those balances to your new card. Most issuers offer a grace period of between 12 and 18 months, during which no interest — or a very low rate will be imposed.
Pay off the transferred amount within that window and you’re golden. Fail to do so and interest rates typically exceeding 25% are applied on the outstanding balance. Some card issuers will charge interest going all the way back to the date the transfer was executed. Some will also apply that rate to the entire amount transferred, even if you’ve paid much of it off.
Home Equity Loans/Lines of Credit are potentially the least costly and also the most risky method of borrowing to pay off credit card debt, home equity loans and lines of credit require you to pledge you home as collateral. This means, you’ll swap unsecured debt for secured debt, putting your home at risk.
In exchange you’ll get lower interest rates than from the other options here, but you could also wind up losing your home if something unforeseen occurs and you cannot pay.
In Summary
Borrowing to pay off credit card debt can make sense. However, you must be careful to choose the best method for your situation — and be certain you can repay the loan as prescribed.
