A recent report gathered in the second quarter of 2018 found that Americans collectively carry $13.29 trillion in debt, which is $618 billion higher than 2008’s peak of $12.68 trillion.
With debt rising, more and more people are turning to personal loans to pay off their high-interest debts, whether that’s medical bills, credit card balances, student debt, etc.
But is taking out a personal loan to pay off your current debt the right choice for you?
Here’s everything you need to know in order to decide if a personal loan is your best option.
Personal Loans Are Typically Unsecured Loans
Unsecured loans are issued mainly based on a potential borrower’s credit score, rather than the borrower’s assets that could be put up for collateral, such as a mortgage, a vehicle, etc. This means you’re not at risk of losing any personal property if you for some reason can’t pay off your personal loan. However, it also means there’s more risk for the lender, and this results in higher interest rates.
Personal loan interest rates are typically combined with other required fees, which is why personal loans have annual percentage rates (APRs) rather than sole interest rates. Personal loan APRs can range anywhere between 2 to 30%. There are a variety of factors that influence your APR:
To decide if taking out a personal loan to pay off debt is right for you, compare the current interest rates on your debts to a personal loan’s rates. If you select a top-rated lender, you’re likely to get better rates, but the rates still may be higher than your current rates.
Personal Loans Range between $1,000 and $50,000
How much debt you’re looking to pay off with a personal loan weighs heavily toward if a personal loan is right for you. Personal loan amounts typically range from $1,000 to $50,000, so if your current debt exceeds that amount, a personal loan may not be worth it for you.
However, there are certain lenders, such as SoFi, that offer loans up to $100,000. But, SoFi’s low rates and high maximum loan amount come with a higher credit score requirement of 680 or above.
When choosing your personal loan lender, consider APR and the amount you need compared to your credit score and debt load.
Consider Your Monthly Payments
If you take out a personal loan, consider if your new monthly payment will be less than the monthly payment(s) on your current debt? You’ll want to run the numbers and do a few comparisons from different lenders.
It’s possible that one personal loan’s payment can be significantly cheaper than your other debt payments combined. This is especially beneficial if your current debt payments are too much for you to handle.
So you know what you’re getting into, compare payments before deciding if a personal loan is work best for your situation.
Personal Loan Repayment Terms May Be Shorter than Other Debts
Personal loan repayment terms typically vary from one to seven years, which is likely a shorter term than your current debt payoff time—especially if your debt is credit card debt.
Before taking out a personal loan, determine if the loan’s repayment length works for your financial situation. If the loan’s repayment term is too quick and risks overwhelming your budget, a personal loan may not be for you.
You don’t want to take out a personal loan and find out later that you can’t afford the payments. If you do, the resulting late payment fees or even loan default will significantly hurt your credit and your life.
Your Credit Score Is a Significant Factor
Although there are personal loans available for people with bad credit, that doesn’t necessarily mean that’s the best option if you have bad credit. Personal loans are most ideal for people with credit scores above 650.
If you’re looking to pay off current debt with a personal loan, you want to make sure you have a high enough credit score first to get you the best interest rates. If your credit score is low enough that you’ll end up paying higher rates than what your current debt has, a loan will hurt more than help.
However, there are plenty of ways to improve your credit score before applying for a personal loan. And it may be worth it to take the necessary time to do so.
Recap—You Likely Should Take Out a Personal Loan to Pay Off Debt When
- You have a good credit score and can qualify for a better APR
- A personal loan will let you pay a lower APR than you’re paying on your current debt
- A personal loan will lower your monthly debt payments
- You have a repayment plan you can stick to and you’re capable of paying off your personal loan within the specified repayment term
- The amount of debt you currently owe is between $1,000 to $50,000 or you have a good enough credit score to qualify you for a higher loan amount if needed