Today we are featuring our first guest post from Josh over at familyfaithfinance.com. Josh lays out an option to refinance credit card debt if you have fallen into the trap and can’t get out.
Credit card debt may not be something we think about much in the FI community because consumer debt is not a tool we typically use and is usually the first thing that is eliminated on an FI journey. But for anyone carrying credit card debt and beginning the FI journey, this is a helpful post.
Some interesting stats about CC debt:
- 38.1% of all households carry some sort of credit card debt.
- The average credit card debt that an American household (carrying a balance) has is $16,425.
- The average household with credit card debt pays a total of $1,292 in credit card interest per year.
- Total Outstanding U.S. Consumer Debt: $3.4 trillion.
On to Josh’s Post:
When it Makes Sense to Use a Personal Loan to Payoff Credit Card Debt
One of the most expensive forms of debt is credit card debt. With interest rates that can easily exceed 20%, you can potentially cut your interest charges in half by transferring your credit card debt to a personal loan. While debt consolidation isn’t always the best option, it can make sense to use a personal loan in the following instances. If you want to eliminate debt from your life, tackling credit card debt is a great place to start.
A Lump-Sum Payment Is Too High
Before applying for a personal loan, you should determine if you can make a lump-sum payment to your credit card company. If you have the savings, this option can be less of a hassle because you don’t have to fill out any application paperwork, review your credit history, or transfer the balance. You can avoid all these additional tasks with a lump-sum payment, and you also won’t pay an application or origination fee.
The lower interest rates of personal loans will automatically reduce your monthly payment. Having a fixed rate loan also gives you a little more certainty with your repayment schedule. Credit card payments are laxer since you only need to make a minimum monthly payment of approximately $25 to keep your account open, even if you might be paying significantly more in interest.
You Have Good Credit
To qualify for a personal loan, you need to have good credit. A loan application will require a credit inquiry that will remain on your history for the next two years.
If you don’t have good credit, a personal loan can have a similar interest rate as your current credit card rate. Choosing the personal loan can still be a better option if you want to cancel your credit cards to avoid future spending temptations. However, you are going to have a harder time saving money or paying the debt off sooner if you can’t get a rate reduction.
Your Debt Will Take More Than One Year to Repay
Lenders will usually give you one to five years to repay your personal loan. Applying for a personal loan makes sense if you need at least one year to pay off your credit card debt because of the lower interest rates. Your interest savings would be marginal when transferring your credit card debt to a personal loan for only a few months. Additionally, interest rates usually become higher if you select a longer repayment term.
There are Multiple Credit Cards
A personal loan can be a good option if you carry a balance on more than one card. Having all your debt in one place reduces the risk of missing a payment because you only need to make one monthly payment instead of three or four. You also have the added benefit of having a single interest rate.
You Won’t “Max Out” Your Credit Cards Again
Personal loans are in some ways a second chance of rebuilding your credit. By transferring the debt to the personal loan, your credit cards will once again be considered “current” and have a full credit limit. The last thing you need to do is go on a second spending spree and plunge further into debt.
Doing so will negate the benefits of a personal loan and end up costing you more money. After transferring your balance to the personal loan, consider canceling your credit card(s) and switching to debit cards.
What About Balance Transfer Cards?
Another option is a balance transfer credit card. You might have received an advertisement in the mail for these credit cards with an introductory offer for 0% APR on all transferred balances for the first 12 to 18 months. These are the equivalent of an interest-free loan minus any transfer fees.
Balance transfer cards can be a better option if you can pay all or most of your credit card debt during the introductory period. After the 0% period ends, the interest rate will return to the normal credit card APR that is currently between 15% and 22%.
There are a few downsides to balance transfer credit cards including:
- The 0% interest rate in temporary
- Some cards charge balance transfer fees
- You need good credit
- It’s another credit card in your wallet
- The account remains open after our debt is repaid
Balance transfer credit cards can be a better option if you only need about 12 to 18 months, at most, to repay the balance. After that, the high interest rate can offset any introductory savings.
Personal loans can be a better option if you want a fixed financial account that only allow you to reduce your balance. There is still the ability to spend more money and increase your credit card debt by opening a balance transfer credit card.
When your credit card debt is too high to continue making payments to the credit card company, personal loans, and balance transfer credit cards can be two effective options. While the 0% introductory offer for a balance transfer card can be good if you can repay your balance in less than a year, personal loans can have a lower long-term interest rate if need several years to repay your balance.
Make sure to check out Josh’s site familyfaithfinance.com.