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Should I use a personal loan to pay off debt?

Can you pay down debt using a personal loan? See how a personal loan can help you manage your finances and how it might help you consolidate debt.

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If you're ready to conquer your debt, there are a few debt repayment strategies you can employ. You could start by paying off your highest-interest-rate debt first, for example. Or you could lock in an easy win by knocking out your smallest credit balance. Either way, you’ll be making progress towards paying off your debt.

To make a big stride toward paying off debt, some people consider taking out a personal loan and using that money to reduce their high-interest-rate debt. Read on to learn more about personal loans and whether they could be a smart option for you, depending on your financial situation.

What's the difference between debt consolidation and personal loans?

A debt consolidation loan is a personal loan specifically designed to consolidate and pay down debt. It often involves a controlled payoff schedule and may have different debt-to-income and credit score considerations because the creditor knows the proceeds will be used to pay off debt.

A personal loan is different than a debt consolidation loan. When you get a personal loan, you borrow money from the bank and agree to pay it back in fixed monthly installments. While personal loans can be used to pay off debt, they can also be used for other personal items like paying for a vacation or for your kid's braces.

Because the use of a personal loan can be broader, a personal loan may have different underwriting requirements than a debt-consolidation loan, such as different interest rates, required debt-to-income ratio and credit score.

Can a personal loan help me pay down debt?

That depends. If you can get a personal loan with an interest rate that's lower than other debt like medical, student loans or credit cards, it may be smart to use a personal loan to pay off higher-interest debt. This decision depends on the interest rate of the personal loan which can vary by lender and by your own personal credit score. Some may be at 6% while others can be at 36%.

The general idea is that a lower interest rate means more of each payment goes toward paying the principal, which helps you pay down the balance faster. Especially if your current debt has a variable interest rate that could rise in the future, consolidation could lower the amount you pay in interest.

Also, having a single loan versus multiple debt sources can help ease some of the stress of being in debt. That's because paying back a single loan is easier than keeping track of multiple payments from multiple sources. You can get peace of mind just from having a plan and making sure you're not paying more interest than you need to be.

However, without appropriate discipline, you could end up in a worse financial situation. Let's say you get a personal loan, pay off your credit card debt, and then run your credit card balance back up. Now you have a personal loan that paid off old debt and you have new credit card debt. Discipline is key! The goal is to pay off debt, not free up ways to acquire new debt.

How to make a plan for paying down debt

If you feel overwhelmed by growing debt, remember the baby-steps approach and the power of small wins. We recommend taking these steps to reduce your debt.

  1. Stop adding to it.
  2. Decide whether debt consolidation makes sense for you.
  3. Shop around for the right loan.

Step 1: Stop adding to your debt.

First, analyze why you went into debt in the first place. Was it a medical emergency that was out of your control, or was it due to overspending? You won't get out of debt unless you stop adding to it.

If it's overspending, it's time to create a spending plan, or budget, that will help you change your spending habits.

As you pay down your debt, it's important to save for emergencies. It may seem counterintuitive to put money aside instead of using it to pay down more of your debt. But if an emergency arises and you don't have money saved, you'll likely end up relying on high-interest-rate credit cards, which will make your debt even harder to pay off.

Step 2: Decide whether a personal loan is right for you.

To determine if a personal loan is a good idea, start by considering your options.
You may need to do some preliminary research to find out what type of loan you can get with your credit score and financial situation. When deciding whether taking out a personal loan to consolidate debt is right for you, keep two questions in mind:

  1. Will it lower the amount I pay in interest?
  2. Will it help me pay off the debt faster?

Keep in mind that a lower interest rate might not save you money if the length of the loan causes you to pay more interest in the long run.

Example A

Let's say you're $6,000 in debt and you're paying it off in $300 monthly increments, as shown in the following table. One debt has a 15% interest rate and the other has a 13% interest rate. You've calculated that you can pay it off in 24 months if you prioritize debt with the highest interest rate.

When you shop around for a personal loan, you discover that you qualify for a 36-month, $6,000 loan at 6.99% interest. This can lower your monthly payments to $185.24, but it’ll take you longer to pay it off. It will, however, save you interest as you'll pay $266.42 less, even with the longer-term loan. That's the value of reduced interest.

If you're struggling to pay $300 a month, this may be a good option. The lower payment can help free up cash for other priorities.

However, if you can afford to continue paying $300 each month, that's when you'll really save on interest payments. If you take the personal loan but continue to put $300 a month, an extra $114.76 monthly toward principal, you could pay it off in 22 months while saving over $400 in interest.

Debt 1: $5,000 at 15%
Debt 2: $1,000 at 13%

Example B

If you have a higher debt balance, the savings can be even more significant. Here's an example of someone who has $15,000 in debt and is making $500 monthly payments toward that debt.

As you can see, consolidating can save them between $421.66 and $1,876.55 depending on how much they pay on the new loan.

Debt 1: $10,000 at 15%
Debt 2: $5,000 at 13%

Step 3: Shop around for the right loan.

Once you determine that using a personal loan can help you save money and pay off debt faster, shop around for the best loan you can find.

Don't just take the first offer or go to the bank where you already have an account. Different lenders offer varying terms like length, interest rate and penalties. Some have different underwriting requirements, such as how they factor credit score and what collateral they might require.

While you're shopping for the best loan for you, consider these factors:

  1. Does your lender charge application fees for the personal loan?
    If so, the fees might offset any savings you get from the lower interest rate.
  2. Are there early payoff penalties?
    The goal is usually to pay off the loan as quickly as possible. You don't want to be penalized for paying off your debt early.
  3. Are you losing credit protection?
    With certain debt like credit cards and student loans, you might have federal or state benefits or protections available to you through the Servicemembers Civil Relief Act (SCRA), state service member benefits or protections, or through a federal student loan. Before you act, take some time to do an analysis that goes beyond just the dollars and cents.
  4. Does the lender require collateral to secure your loan?
    Some lenders may require collateral, such as a home or savings account held at their institution. If they don't, you may get a discounted interest rate by backing your loan with collateral.

And remember, when you pay off your debt, plan a budget-friendly celebration. After all, it's been a long journey that's required a lot of discipline. Then reset your budget so you're spending less than you earn and don't go into debt again. Also, you can find more information and steps to get out of debt at usaa.com/debt.

Think a personal loan can help you pay down debt faster?