Ensuring timely payment of your credit card bills is a wise financial habit. However, even a single missed payment can lead to repercussions. In such circumstances, you might want to contemplate obtaining a personal loan to alleviate your increasing debt burden. Alternatively termed as a debt consolidation scheme, this procedure entails acquiring a personal loan to settle your outstanding credit card balances. Engaging in this approach offers numerous potential advantages, including:
- Reduced interest rate: Personal loans generally feature lower interest rates compared to credit cards, particularly for individuals with good credit. This can result in long-term savings on interest expenses.
- Streamlined payments: Rather than managing various credit card payments, you’ll only need to make one monthly payment towards the personal loan.
- Clear payoff timeline: Personal loans come with a fixed term, providing clarity on the duration required to clear your debt completely.
Converting your credit card debt into a personal loan
Clearing your credit card debt with a personal loan doesn’t equate to being debt-free. However, it does mitigate the risk of monthly high interest payments. Before transitioning your credit card debt to a personal loan, it’s crucial to contemplate several key factors:
- Interest rates: Credit cards often impose exorbitant interest rates, sometimes as high as 45%. On the other hand, personal loan interest rates typically range between 11.5% and 24%. If you secure a personal loan with a substantially lower interest rate than your credit card, it can lead to long-term savings. Nonetheless, it’s essential to note that if your credit score is less than stellar, you may not qualify for a favourable rate on a personal loan, thereby nullifying the potential benefits.
- Overall expenses: Take into account not only the interest rate but also any origination fees or prepayment penalties linked with the personal loan. These additional fees can contribute to the total cost of the loan. Compare this total cost to the interest you would accrue if you retained the debt on the credit card.
- Debt management strategy: Acquiring a personal loan doesn’t automatically resolve your debt challenges. Ensure you establish a robust plan to repay the loan promptly and completely. This involves adhering to a budget and abstaining from accumulating additional credit card debt. If necessary, contemplate seeking assistance from credit counselling services to develop an effective plan.
- Credit score implications: Although settling credit card debt can enhance your credit score, obtaining a new loan may initially lower it temporarily. Nevertheless, the favourable effect of clearing high-interest debt generally surpasses the short-lived decline attributed to the new loan.
Transitioning from credit card debt to a personal loan might offer a sense of starting anew. Nonetheless, it’s crucial to avoid the urge to utilise your newly available credit card limit to accumulate fresh debt.
Frequently Asked Questions (FAQs)
Q. What facilitates a faster debt repayment by substituting credit card debt with a personal loan?
A personal loan typically offers a fixed equated monthly installment (EMI) and interest rate for a predetermined duration, ranging from one to five years. Upon consolidating your debt, you can expedite loan repayment within a short timeframe, making single monthly payments at a consistent interest rate. Unlike credit cards, which lack defined repayment periods, it’s easy to overlook the ongoing accumulation of interest until the debt is settled.
Q. What are the disadvantages of taking a personal loan to consolidate debt?
Although personal loans offer a means of consolidating debt, it’s important to take note of certain drawbacks that include:
- Effects on credit score: Initiating a new loan application may lead to a temporary decrease in your credit score.
- Risk of overspending: While settling credit card balances can increase available credit, it’s important to avoid accruing fresh debt.
- Eligibility requirements: Securing a personal loan with a favourable interest rate typically demands a good credit history.
Q. What are the typical causes of personal loan denial?
There are several common reasons why a personal loan application may face rejection:
- Low credit score: Lenders consider this as a significant factor, indicating a higher risk of loan default.
- High debt-to-income ratio (DTI): A high DTI may suggest difficulty in managing additional loan payments compared to your income.
- Insufficient income: Lenders require assurance that your income can cover existing debts and the new loan payment.
- Unstable employment history: Frequent job changes may raise concerns about your ability to repay the loan.
- Incomplete or inaccurate application: Providing all necessary documentation and accurate information is essential to avoid rejection.
- Multiple loan applications: Applying for numerous loans in a short period may signal desperation for credit, negatively affecting your credit score.
- Loan purpose not meeting lender criteria: Some lenders may have specific restrictions on how loan funds can be used.
Q. Which factors influence the interest rate of your loan?
Numerous factors influence your personal loan interest rate. Below are some of the key ones:
- Credit Score: This holds significant weight. A high credit score, usually exceeding 700, signifies a commendable credit history and prudent borrowing behavior. Consequently, lenders view you as a desirable borrower, potentially qualifying you for a reduced interest rate.
- Debt-to-income ratio (DTI): This ratio juxtaposes your total monthly debt commitments with your gross monthly income. A lower DTI signals to lenders that you possess greater disposable income to fulfill loan repayments, potentially leading to a decreased interest rate.
- Loan amount and tenure: Typically, shorter loan terms and smaller loan amounts often entail lower interest rates. Lenders perceive them as less risky propositions.
- Employment history: Demonstrating stable employment with a reputable employer indicates to lenders that you possess a dependable income source for loan repayment.
- Relationship with the lender: Existing patrons of a bank or credit union may be eligible for preferential interest rates on personal loans due to their established relationship.
- Market interest rates: The broader economic climate and prevailing interest rates can also influence the interest rate offered on a personal loan.
Q. How can you discover the most favourable personal loan offer?
Once you’ve determined the loan amount, seek out the most competitive personal loan offer considering factors such as interest rates and tenure. Inquire about personal loan options from banks and NBFCs where you hold existing deposit and/or loan accounts, as many offer preferential rates to existing customers. Next, compare interest rates offered by various lenders. Additionally, explore offers from other lenders. However, for a comprehensive comparison, consider utilising online lending marketplaces. These platforms enable you to compare personal loan options from multiple lenders based on your credit profile, all without impacting your credit score.
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Published: 27 Mar 2024, 08:06 PM IST