Getting a Loan to Pay Off Credit Card Debt
The idea behind applying for a loan to pay off debt is that you are trading high interest credit card debt, for a low interest loan with a very long term payment strategy.
It is essentially a debt reorganization. You rearrange your finances to provide yourself with a more manageable monthly payment…that is the basic idea. But, before you commit to this process, you need to ask: is acquiring new debt, to pay off older debt really a smart idea?
There are 2 main factors that should decide whether a loan is right for you.
1) The Interest Rate of Your Credit Cards: if you can trade 20%+ interest rate on credit cards for an 8% home equity loan, that makes decent financial sense.
2) Your Ability to Pay Off this Loan in the Long Term: can you predict what will your finances look like 5 years from now? A loan is commitment that could span a decade or more. You truly need to understand the ramifications of your loan and how it could affect your life in the future.
Should you get a Loan to Pay Off Debt?
Well, it depends… Are you the type of person that is financially stable but had unusual circumstances like a medical issue, or loss of job, that caused your debt? If so, then a low interest loan might help you get out of a tough bind. It could be the key to lowering monthly expenses, and allowing you to save enough cash to make a real dent in your debt. If this doesn’t describe you + you have a track record of poor spending habits and unsteady income flow, then a loan might just end up creating future headaches.
One reason a traditional loan can cause problems is because you will need collateral. Credit card debt is a type of “unsecured debt“. Unsecured debt means that it does not require collateral to be borrowed. If you don’t pay your credit card bills there are very serious consequences. Your unpaid credit card bills can lead to damage to your credit score, court judgements, wage garnishment, or a lien on property. But, home equity loans and debt consolidation loans, are different. These loans are usually secured and will most likely use your home as collateral. If you default on those payments, the bank will foreclose, and you will be without a home. So, the real question is, are you willing to pay your credit card debt at the risk of losing your home?
Right now some banks are starting to offer unsecured debt consolidation loans. These loans will not have as good terms as a secured loan. They will also require good credit and current employment. You might not have either if you aren’t current on your credit cards. But, if you can get one at a lower rate than your credit cards, it might be worth it.
Getting a new loan involves fees.
When you get any type of loan, there are upfront expenses. You be charged more fees depending on the type of loan, and what institution you go through. If you decide to apply for a home equity loan, the fees might be minimal, plus the interest is tax deductible. But, this requires you to put up your house, which can be unnerving. So, if you don’t want to put your house on the chopping block and instead opt for a personal loan, you will field a higher interest rate of around 11%+ or more. There are pros and cons to weigh for each option. You need to ask yourself: With all the costs and fees bundled in, will you truly be paying less?
Another avenue you might explore is your local credit union. These lending institutions operate very differently from banks and may be much more forgiving with interest and fees. If you can’t get decent terms with your bank, go down to your credit union and see what they have to offer.
Fixed loans are better than variable rate credit cards
Credit card companies have hit hard times lately. The poor economy is causing default rates to sky rocket and the recent CARD act has essentially made their businesses less profitable. Credit card companies have already begun to convert most of their fixed rate cards to variable interest rates, to increase profits. These variable rates are tied to certain benchmarks of the economy, like the prime rate (which fluctuates up and down). With that being said, fixed interest rates are always preferable, because no one can predict what will happen to the economy. The economic mess we are facing now came about because of adjustable rate loans. If you are getting any type of adjustable rate loan, you need to factor in some instability. Getting a lower interest fixed rate loan to pay of a variable rate card might give you peace of mind in this unstable economic time.
Have you tried to negotiate a lower interest rate first? (do this right away)
If you are considering a loan, the first thing you should do is try to haggle for a lower interest rate on your credit cards. Your monthly payment might become manageable and you might not even need to borrow. The secret that most consumers don’t know is that if you ask for a better rate, you’ll usually get it! If you explain your position to a rep, you can often produce some sort of deal that is mutually beneficial. The company wants you to stay current on your payments, and you want a more manageable monthly payment. These types of agreements are part of their business model and they make deals with customers every single day. All it really takes is a 10 minute phone call, and your ability to express the type of financial situation your in. Making this phone call should be number one priority, waaaay before considering a loan.
Conclusion
Hopefully this list of pros and cons, can give you an idea about whether a loan would be helpful in your unique situation. There is no one answer, because people have very different credit card interest rates, credit scores, spending habits, and employment histories that will make one option better than another…If you decide to get a loan, think of where you will be at the end of the loan term. If you can’t predict what your finances will be like, then maybe a loan isn’t for you.
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