Education Center

Using a Personal Loan to Pay Off Credit Cards

Two options for using a loan to eliminate unsecured credit card debt.

Trading one type of debt for another

When it comes to credit card debt, there are plenty of ways available to eliminate it when traditional payment methods aren’t working. Two of those options involve personal loans.

In normal circumstances, you pay your credit card bills every month on a schedule that works for your budget. Ideally, this means paying more than the minimum amount requested, since sticking to minimum payments has a way of leading to debt problems.

When this kind of problem occurs, you need to find an alternative way to eliminate that debt as quickly as possible so you don’t start missing payments and facing defaults that damage your credit score.

What is a personal debt consolidation loan?

When you take out a loan to pay off your credit card debt, it’s called a personal debt consolidation loan. Basically, you’re rolling all of those debt payments into one bill – hence the concept of “consolidation.”

You take out enough money to eliminate your other debts. So when you receive the loan, you immediately turn that cash around to pay off all of your outstanding credit card debt in full. This zeros out the balances on your credit cards, so as a result the only obligation you have to worry about is the loan, itself.

You have two goals when you apply for a personal consolidation loan:

  1. Get enough money to pay off all of the outstanding credit card debt that you have.
  2. Qualify for the lowest interest possible so you can pay off the debt quickly and efficiently.

Achieving these two goals is really dependent on your credit score. If you have excellent credit, you can usually qualify without issue for either type of loan you can use for consolidation.

Secured vs. unsecured consolidation loans

The difference between the two types of consolidation loans involves whether the loan is secured or unsecured. A secured loan requires some kind of collateral from the borrower, while an unsecured loan doesn’t.

Collateral is an asset that you borrow against; it protects the lender so in case of default, they can repossess the collateral to cover the remaining balance. For most secured debt consolidation loans, the collateral is your house. This is also called a home equity loan. You borrow against the equity you have built up in your home.

It should be noted that there are other differences with these two types of loans. One of the benefits of many home equity loans (also called a home equity line of credit or HELOC) is that you only have to pay the interest for a certain period of time. This means you have low payments in the beginning that jump a few years down the road.

Fact: According to TransUnion Corp., as much as 20% of HELOCs may default in 2014 as boom-era loans roll into higher payments.

Unsecured loans typically don’t have this feature. This means you have higher payments from the outset, but once you get used to the payments, you don’t have to worry about them increasing later.

It’s actually easier to qualify for a secured loan because the lender has your collateral for a safety net, so you may be able to qualify for a home equity loan at a better interest rate than an unsecured loan. Of course, you have to weigh if the interest rate and terms are worth the risk.