When is a personal loan a smart choice? - KTRE.com | Lufkin and Nacogdoches, Texas

When is a personal loan a smart choice?

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By Andrew Housser

If you are considering applying for a personal loan to consolidate and pay off credit card debt, you likely have some questions. Is a personal loan the right choice for you? Would a balance transfer be a better option? How much will it cost? 

The popularity of personal loans continues to climb. In the last quarter of 2016, nearly 16 million consumers had a personal loan. If you are deciding whether to use a personal loan or a credit card balance transfer to help eliminate your credit card debt, consider these questions. 

Does your credit score reflect your level of financial responsibility? If you have good credit, you may receive balance transfer offers from credit card issuers. These often offer very low, or zero, interest rates for a limited period. But if your credit scores do not reflect repayment capabilities, it may be time to look at a personal loan. Some of the new independent lenders use different criteria than a traditional bank or credit union to evaluate how likely a person is to repay a loan. They may have a direct conversation with you that allows you to provide information about your credit profile, savings and other factors that indicate you are financially responsible. 

Which costs more: the personal loan’s origination fee or the credit card balance transfer fee? With a balance transfer, you may pay a transfer fee of 1 to 5 percent of the amount transferred. Personal loans usually charge a flat origination fee of 1 to 5 percent of the loan amount, too. However, in the case of a balance transfer, you must pay careful attention to the date when the promotional period ends. If you do not repay the credit card balance before that date, you will begin paying a regular interest rate (averaging more than 15 percent annually). Alternatively, some people end up transferring balances to yet another card, paying another transfer fee. Multiple fees can add up to much more than a personal loan’s origination fee.

How do the interest rates stack up? In general, personal loans provide slightly lower rates than credit cards. Credit cards can carry interest rates of 15-25 percent. A personal loan can lower that rate by two to four points. Over time, the interest rate can make a significant difference in your total payment. If you repaid $10,000 in credit card debt over 60 months at 20 percent interest, your payment would be $265 per month. You would pay a total of nearly $5,900 in interest. Over the same 60-month period, a personal loan at a 15 percent interest rate would cost $233 a month and save almost $2,000 in total interest.

How disciplined are you? To repay a personal loan, you will need to meet strict monthly payments and timelines. Typical terms for personal loans are 36 or 60 months. Many lenders will arrange an automatic debit plan, where they automatically withdraw your monthly payment from your account. With a credit card, it is up to you to determine the amount you pay each month. That may range from the minimum due to the full balance.

Do you have a plan to avoid getting into more debt? If you suspect you will be unable to avoid going into more credit card debt after you pay off the balance with a personal loan, you may need to store credit cards in a safe place where you cannot easily access them. (Be careful in closing accounts, though, as the longer you hold a card, the more valuable it is in your credit score determination.) Whether you use a personal loan or balance transfer to help eliminate your debt, look at the real reason you got into debt in the first place. Address the root cause. Then establish a realistic budget and commit to living within your means, no matter how hard it may be.

Can you make the payments? It is important for consumers to honestly evaluate their complete financial situation. If you are struggling to make minimum payments on your current credit card debt, a personal loan likely is not the best option. In this case, it becomes important to look into other options, such as debt negotiation (settlement).

If your answers to these questions seem promising, it may be a good idea to learn more about personal loans and how one might work for you. Just remember that a personal loan can be a helpful tool for eliminating credit card debt, but is not a license to spend.

Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.
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