Dealing with debt, or a bunch of different debts? Looking for a better strategy to pay it off? Depending on the nature of your debts, your overall financial situation, and available interest rates, one option worth considering is using a personal loan to pay off your debts.
Whether you use the loan to consolidate and pay off several different debts at once, or use the loan to tackle a single debt, the idea is to wipe your financial slate mostly clean, leaving just the loan to take care of, and giving you a simple, predetermined repayment schedule to follow.
Save on interest by borrowing at a better rate
Is using a personal loan to pay off debt the right approach for you? Putting aside the cost of loan fees and any potential prepayment charges, it’s generally only worth getting a loan to pay off a debt (or debts) if you’re able to borrow money at a lower interest rate than whatever you’re paying on the debt you already have.
For instance, say you’re carrying a balance of around $500 on your credit card at 20 per cent interest. At the same time, you’re also paying off a $5,000 line of credit you used to cover the cost of some home repairs, at an interest rate of five per cent.
If your financial health is good enough, it shouldn’t be too hard to get a personal loan at a lower interest rate than the one charged by the credit card company. However, to come out ahead, you’ll also need a loan with a lower interest rate than the five per cent you’re paying on the line of credit.
Of course, some people who end up in difficult debt situations are viewed as high-risk borrowers by banks and financial institutions and aren’t able to access the most favourable interest rates as a result. If your credit history is poor, you’ll likely have to shop around, perhaps using an alternate lender more willing to give you a competitive interest rate.
Cost-certainty and a fixed schedule
While some personal loans have variable interest rates, it’s usually possible to lock in a fixed rate. With a fixed rate, you’ll always know exactly how much each loan payment will be, allowing you to budget more accurately and effectively. By following a fixed repayment plan for the loan, instead of staying on top of different payment dates for various dates, you’ll give your repayment efforts more clarity and stability.
One more thing worth mentioning, especially for those using a personal loan to pay off credit card debt, is that each loan payment will likely be bigger than the debt-servicing payments you were making previously. Be aware of the potential for bigger monthly payments with a personal loan and ensure these don’t cause any day-to-day cash flow problems for you.
Don’t be undisciplined after paying off debts
If you use a personal loan to wipe out a bunch of debts, the last thing you want to do is slip into a feeling of financial comfort and complacency and start spending too much money. Favourable interest rate or not, don’t forget that your loan still represents a debt that needs attention, and that your credit rating could suffer if you aren’t able to keep up with the scheduled repayment plan.
Be aware of costs and fees
If you’re considering using a personal loan to pay off debts, remember to include any costs and fees in your calculations, and make sure these don’t erode too much of the savings you’re trying to generate.
If possible, look for a loan that allows you to pay off the principal ahead of schedule without charging you any penalties. That way, if you’re in position to wipe out your debt in advance, you can do so without it costing you a dime.