Borrowing from one pocket to fill the other isn’t always a bad idea as many people would like to think. In fact, it can be an awesome idea. Personal loans, for example, can be a great way to pay off credit card debt, repair your score, and even lower the interest.
However, you must get it right; otherwise, taking out a personal loan could see you end up in a worse financial situation than when you started. In addition, there are certain things a personal loan will and will not do.
- Your credit card debt will not disappear after taking out a personal loan. It’ll only refinance the loan at favorable rates.
- Credit card debt is referred to as revolving debt, which means there’s no fixed repayment period. A personal loan will transform the loan in a non-revolving debt with a fixed repayment period. Often, the repayment will go up to 5 years.
- You can also use a personal loan to improve your score. Your FICO score is made up of multiple elements, one of them being credit mix; that takes up 10%. If you only have one type of debt, your score may suffer. However, multiple types of credit such as a personal loan, credit card debt, and mortgage can boost your score.
- You can extend your credit card debt term by taking out a personal loan, although this will depend on how much you pay on your card debt. The downside to this is the cost of the debt may go up. If you don’t have any other option, and your top priority is to reduce the monthly payments, then this advisable to go for a short term.
Evaluate Your Score Before Applying for a Personal Loan
Before you can think of applying for a personal loan, it’s wise to know where you stand in terms of your credit score. Remember, this is what lenders will consider when considering your application. In addition, it’ll also allow them to know what interest rate to set on the loan.
To check your credit for free, visit annualcreditreport.com. You can also get a free look at your score from the leading reporting agencies: Experian, Equifax, and TransUnion.
Most lenders will prequalify you and also allow you to check your rates, all without performing a hard credit check. This means you have nothing to lose when you apply and see the rates you’ll get. Here’s a breakdown of scores and what they mean:
- Over 740: This means your score is excellent and lenders will offer the lowest rates in the market.
- Over 700: Your score is good but not excellent; and there’s a high probability of landing a loan with favorable interest rates.
- Under 700: This kind of score is considered poor. However, you can still qualify for a loan, although you’ll pay high-interest
- Under 640: This is considered bad credit and finding a lender and eventually qualifying for a loan will be an uphill task. If you find one, prepare for sky-high interest rates.
Improve Your Score
Life happens, and you can find yourself with a poor credit score. It’s not the end of your financial life as many people believe. You can still improve your credit score and get back to the glory days.
This is important before you can apply for a personal loan or any other loan for that matter. By doing this, you’ll end up saving hundreds or even thousands in interest.
The easiest way to boost your score is by making on-time bill payments. Also, consider lowering your credit utilization ratio. This is the ratio of your debt to the available credit. It’s recommended that you keep this figure below 30%.
Don’t forget to analyze each entry on your credit report. Sometimes, the reporting agencies make costly mistakes, such as including a negative entry you have no relation to whatsoever. In fact, up to 25% of consumers end up with such entries on their reports that weren’t of their own making.
If you have a credit card debt, it’ll be wise to clear this debt before you can even think of saving. Don’t get it twisted and having an emergency fund to cover unexpected expenses is wise as well. However, if intend on using a personal loan to consolidate credit card debt, it means you don’t have a lot of “free” money, which makes paying off the debt using savings a futile attempt.
In fact, many people make this mistake. They stash away a lot of money in their savings account, but what does that offer as interest? The most you’ll get is 2% per year. On the other hand, you’re paying down a credit card debt with 7 to 8 times the savings interest (15%, 20% or even higher). It doesn’t make sense at all.
Hunt for the Best Personal Loan
Finding a personal loan that suits your financial situation is similar to going shopping. There are numerous lenders with varying terms and conditions. This means you’ll have to do a lot of rounds on the internet to find the best lender, especially your credit is poor.
Fortunately, and unfortunately, numerous just right loans lenders focus on borrowers with bad credit. You’d think that’s a great thing. Well, yes. That’s the fortunate part. The unfortunate part is that these lenders are predatory because they feed on the desperation of these people.
They know their borrowers have poor credit, are in a financial jam that needs a fast solution, and they don’t have an alternative. Payday loans are one of the loans with APRs going up to an insane 700%.
You can opt for a secured personal loan such as a home equity line of credit (HELOC) or a car title loan. As the name suggests, these loans use your assets as security .and this is why you need to tread with caution when taking them out.
The interest rates may be lower compared to unsecured loans, but if you fail to make the payments, the lender will sell the asset to recover the loan balance.
Consider Affordability and Whether a Loan Makes Sense
The only time consolidating your credit card debt using a personal loan will make sense is if it will save you money on interest or reduce your monthly payments. The latter should be in the top of your mind if you have several loans such as a car loan or a mortgage and are having trouble making ends meet.
However, this will come at an expense, which is increasing the interest rate charged on the debt. This means there’s a chance that a personal loan will not save you money. You must check the terms and interest rates offered by the lender before making an application.
Affordability is also key when taking out a personal loan, if you intend on saving money through lower interest. Therefore, the fees and interest rate should be lower than what the credit cards charge.
If you do this, consider the monthly payments and whether you can meet them. The best move is to keep the terms as short as you can. This will result in higher payments, but you’ll end up saving a lot of money.
Do Thorough Research
Often, many people rush to sign on the dotted line without reading the terms and conditions, something that comes back to haunt them later on. For example, will the lender charge early payment fees after you make a financial breakthrough? Are there origination fees? These are fees charged through deduction from the total loan amount before you can receive the funds in your account. For example, if you borrow $5,000 and the lender charges 5% origination fee, you’ll only get $4,750 in your account.
You also want to check the company’s status on the Better Business Bureau. This website will give you information on whether the company has had legal issues in the past for whatever reason. Don’t forget to also check whether they have an active license.
For your score to improve, the lender must report your good behavior to the credit reporting agencies. Therefore, it’s in your best interest to find out whether the lender does so. You have to do this because the law doesn’t require them to file that report; because there are administrative costs involved, they’d rather do it only if you skip payments.
The choice is certainly yours whether to take on another loan or not, but whatever route you decide to take, look at all the options, charges, and potential problems.
By Ann Jarema