Should You Use a Personal Loan to Pay Off Credit Card Debt?

Drowning underneath a pile of expensive credit card debt? Don’t have the cash to write a big check to pay it off? Are the maxed-out cards killing your FICO and VantageScore credit scores? If so, you’re certainly not alone. Nationally, total credit card debt climbed to over $1 trillion last year, according to the Nilson Report.

It’s no secret that excessive credit card debt often foreshadows serious financial problems. In fact, if you currently owe more on your credit cards than you can afford to pay off this month, then you’re already in trouble and wasting your money. To add insult to injury, that outstanding credit card debt that’s hurting your wallet could also be hurting your credit scores.

Why Credit Card Debt Hurts Credit Scores

Many consumers find it surprising that even “on-time” credit card accounts can damage credit scores. The truth is it takes a lot more than good payment history to earn a great credit score. Payment history is just one piece of the much larger puzzle. Outstanding credit card debt can have a negative credit score impact even if you make all your monthly payments by the due date.

Credit scoring models like FICO and VantageScore are designed to compare how much credit card debt you owe (balances) with how much you are eligible to spend (limits). This relationship between your credit card balances and limits is referred to as your debt-to-limit ratio or your revolving utilization ratio.

You can calculate your revolving utilization ratio on a credit card account by dividing the balance by the credit limit and multiplying that number by 100. For example, if you have a credit card account with a $5,000 limit and a balance of $2,500, then your revolving utilization ratio is 50% (2,500 ÷ 5,000 = 0.5 X 100 = 50%). Pay that balance down to $1,000, and your new revolving utilization ratio would be 20% (1,000 ÷ 5,000 = 0.2 X 100 = 20%). The higher that percentage, the lower your credit scores… it’s that simple.

Related: Why Credit Utilization Is Such a Big Deal

The Personal Loan Solution

Naturally, if you can afford to write a big check and pay off all or a big chunk of your credit card debt, then you should probably do so. Yet if paying off your credit card debt all at once is impossible, there are still some other smart ways to handle your credit card debt. Paying off your credit card debt with a personal loan is one such solution. Here are two big reasons why:

1. It can be cheaper debt.

Credit card interest rates are typically among the highest rates you will ever pay. It is not unusual for general use credit card (American Express, Discover, MasterCard, Visa) interest rates to rise well over 15%, even for people with good credit. Interest rates on retail store credit cards are almost always well into the 20s.

By comparison, personal loan interest rates are often much less expensive, especially if you have decent credit. (It goes without saying that a high-interest personal loan – they can also climb past 20% for applicants with mediocre credit – will not be very helpful.)

2. It’s almost guaranteed your credit scores will improve.

Personal loans are unsecured installment loans, not revolving accounts like credit cards. As a result, when you carry outstanding debt on an installment loan, your scores are not impacted in the same negative way as they are when you carry outstanding revolving debt. In fact, the balance you carry on an installment loan typically counts against you very little, if at all, from a credit scoring standpoint.

And remember that math problem we did above just a few moments ago? If you were to convert your revolving credit card debt into installment debt, then the “revolving utilization” problem ceases to exist, because installment debt isn’t factored into that math problem.

In fact, if you were to pay off your credit card debt over multiple cards with an installment loan, your debt-to-limit ratio may very well go to zero, and your scores will likely shoot through the roof — provided you keep up to date on payments with your new personal loan.

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John Ulzheimer is an expert on credit reporting, credit scoring, and identity theft. He has written four books on the topic and has been interviewed and quoted thousands of times over the past 10 years. With time spent at Equifax and FICO, Ulzheimer is the only credit expert who actually comes from the credit industry. He has been an expert witness in over 230 credit related lawsuits and has been qualified to testify in both federal and state courts on the topic of consumer credit.

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