Using personal loans to pay off credit card debt

By Gary Foreman

The New Frugal You

Gary Foreman is a former financial planner who currently edits The Dollar Stretcher website and newsletters. He writes "New Frugal You," a weekly Q&A column about frugal living, for CreditCards.com Ask a question. 'New Frugal You' archive

Dear New Frugal You,
Is it a good idea to take out a personal loan to pay off credit cards? I owe over $11,000 on three different cards. My credit union is advertising personal loans. I'm guessing that their rates would be a lot lower than what I'm paying on the credit cards. I'm hoping to save 10 percent. I have two questions. Do you think that they'll really loan me the money? And, if they will, should I do it? -- Emilio

Dear Emilio,
You're right. A difference of 10 percent on $11,000 is close to $100 a month in your pocket. That's a lot of money to lose, especially if you have an alternative.

But it's not just a matter of doing the math. There are other things to consider. So let's examine the whole range of possibilities.

We'll begin by seeing what can be done if you stay with credit card debt. There are a couple of tools available to you.

Ask the credit card companies for a lower rate. If you have a good payment history (no late payments or going over your credit limit), there's a good chance that they'll adjust your interest rate.

You'll increase your chances of success if you know what you can realistically ask for, so start by comparing credit card rates and then ask your current company to match the lowest rate. If your current card company won't drop your rate, you can do a balance transfer to the lower rate card.

Failure to get a lower rate or find a transfer deal could mean that you're heading for debt trouble. In that case, you might want to check out credit counseling. It's designed to get you budget counseling, a lower rate on your cards and minimize any hit to your credit score. Find one that's a member of the National Association for Credit Counseling or The Association of Independent Consumer Credit Counseling Agencies. Most offer a free, no-obligation initial assessment.

Once you have an idea of what can be done with your credit cards, it's time to get some info from the credit union.

Don't be overly disappointed if they turn you down. Banks and credit unions have been cautious about loans recently. At times it almost seems like the only people who qualify for loans are those who don't need them.

But it can't hurt to go in and talk to the credit union. It should be able to tell you pretty quickly whether you're likely to qualify for a loan and what the approximate interest rate would be.

Make sure that you understand any fees and the interest rate you'll be charged. You want to have a fair comparison. Best if you can have both loans quoted in APR (annual percentage rate).

If you borrow from the credit union, make sure you understand what, if anything, secures the loan. They may ask you to back the loan with collateral -- perhaps by pledging to surrender your car, a certificate of deposit or other savings-type account if you default.

Putting up collateral could be important to you. If you stopped paying a credit card bill, it's unlikely that they'll sue you to take your car. But if your car is pledged to a loan and you default, it would get repossessed. Going from an unsecured to a secured loan always adds some risk -- or more accurately, it shifts risk from the lender to you.

Be sure that you can handle the payments on any personal loan. Unlike credit card debt, personal loans tend to have a relatively short term, which means that the monthly payments could be higher. Don't commit to a payment schedule that you can't meet.

If you do use a personal loan to pay off the credit cards, don't let the new zeroed balances tempt you. Clearing them doesn't give you an excuse to start building a new balance. Commit yourself to paying the entire balance each month.

That brings us to an important point. Lowering the amount of interest you pay on borrowed money is usually a good thing. But an even better solution is to repay the principal and eliminate the debt. Then all of the money that you've been paying in interest can be used for other things.

See related: Using personal loans to consolidate debt, Personal loans offer less-risky credit card alertnative

For more than 35 years, Gary Foreman has worked to help people get the most for their money. Prior to founding The Dollar Stretcher.com, he was a financial planner and purchasing manager. Gary began The Dollar Stretcher website and newsletters in April 1996. Today the website features more than 6,000 articles on different ways to live better for less. Gary has been interviewed by The Wall Street Journal, The Nightly Business Report, USA Today, Reader's Digest and other newspapers and magazines. Gary answers a question about a budgeting or saving issue from a CreditCards.com reader each week. Send your question to The New Frugal You.

Published: September 27, 2012

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