We get a lot of emails from people who are really up to their eyeballs in debt. One question we get asked time and time again is, “Should we get a personal loan to pay off our credit cards?” Each situation is different.
The reason why people ask us this question is very simple. On a credit card you are paying 20% plus a year on interest, where on a bank loan you are paying 10% a year interest. The difference while only 10% is huge in dollar terms over a year and it can mean the difference in paying down an amount of debt in a much quicker time. The answer seems pretty easy right; well there are many shades of grey in the answer.
However there are a couple of questions you should ask yourself. Only when you can answer YES to each question should you think about getting a personal loan to pay off your credit card.
1. Once the credit cards are paid off will I cancel them?
There is no use in paying off your credit cards in full only to start at a zero dollar balance and start racking up debt on them again. Just because you pay down your credit card to zero, the card company doesn’t cancel them. You need to request this. We have known people in the past who have done this and continued to use the card like it was someone else’s money. Fast forward a year. They now have a portion of the original debt on a personal loan, plus their credit cards are in same debt position they were when they took the loan out. You need to be able to cancel the credit card 100% when the balance has been paid down.
2. Are you comfortable with your home budget?
Are you just scraping by month to month? Or do you need to resort to credit cards to make up the difference. Many people believe if they take out a personal loan to pay off their credit card this will be the answer to their budgeting problems. They take out a personal loan, pay off their credit card, they take our advice and close their credit card. However then tragedy strikes, their fridge breaks down. Due to the fact they are living pay cheque to pay cheque they have no money saved. As quickly as you can say, “I’m doing something that is not very smart” they are back onto any credit card company for a quick approval to get a new plastic card to cover the fridge. Or they are down at the shops taking up an interest free offer on a fridge. Before you take out a good personal finance blogs to get out of debt personal loan, test yourself. Run through a few scenarios in your mind. What would happen if you needed $1000, $2000 or $3000 quickly? Could you cover it without resorting back to opening a new credit card?
3. Have you got a debit card?
There are some payments in this world where you need a credit card number. Let’s face it, over the phone and internet shops, sometimes credit cards are the only way to pay. A debit card allows you to have all the advantages of a credit card but you use your own money. So there is no chance of being charged interest. When closing down your credit card, make sure you have already set up a debit card. Make a list of all the monthly automatic direct debits. You can easily call these companies and get them to change your monthly automatic direct debits to your debit card. You don’t want to start getting late fees due to your credit card being closed when companies try to make withdrawals.
4. Can you make additional payments on your personal loan without being penalised?
While credit cards are a financial life-sucking product, they have one good advantage. You can pay more than the minimum payment without getting penalised financially. For example, if you had $20,000 owing and paid off $18,000, there is no penalty for this. Personal loans are not always this cut and dry. There are two different types of personal loans to consider; fixed interest and variable interest.
The big difference is with variable interest you can make additional payments without being penalised (or just a minor fee is charged on the transaction depending on the bank). However with fixed interest, you are agreeing to a set amount of interest over the course of the loan. In fact you could pay out a 5 year fixed interest loan in 6 months and you will still be charged the full five years of interest.