If you’re struggling with multiple high-interest credit card balances, it can be overwhelming to manage multiple payments, due dates, and track all of the interest expense accruing on your cards.

One solution that many people turn to is using a personal loan to consolidate their credit card debts into one loan with a single monthly payment.

This strategy simplifies your debt and can save you money in the long run by reducing your overall interest payments. Deciding whether a personal loan is the right option for you can be challenging, so it’s important to research all of your options and fully understand the implications.

In this article, we’ll examine how debt consolidation can help your financial situation and credit score, and we will review an example scenario for an individual with several credit card balances.

What is Debt Consolidation?

Debt consolidation is combining multiple debts with different lenders into a new loan with a single monthly payment. By having one loan, you only have to worry about one lender, one interest rate, and one monthly payment, which is significantly easier than having multiple accounts with different lenders.

Lower Interest Rates on Personal Loans vs Credit Cards

One of the greatest advantages of using a personal loan to consolidate credit card debt is the potential to secure a lower interest rate. The Annual Percentage Rate (APR) on a credit card typically ranges from 15% to 30%, depending upon the creditworthiness of the account holder. Personal loans, however, often have interest rates ranging anywhere from 4% to 36%.

For some individuals, the personal loan interest rate may be higher than their credit cards; however, most borrowers will find the rates are lower.

Fixed Monthly Payments

Credit cards are revolving debt, meaning your minimum payment changes depending on your account balance and interest rate. With a personal loan, your payments are fixed over the life of the loan. This means your monthly payment amount stays the same, making it easier to budget.

Fixed payments give you a clear path to becoming debt-free since you’ll know exactly when your loan will be fully paid off. Most personal loan terms will range anywhere from 3 to 60 months. Lenders will adjust the interest rate and monthly payment amount depending upon how many months you want to repay the debt.

Boost Your Credit Score

While it may seem counterintuitive, consolidating credit card debt can potentially improve your credit score. You credit utilization (the amount of credit you’re using compared to your total available credit) accounts for approximately 30% of your credit score.

By paying off your credit card balances with a personal loan, you reduce your credit utilization ratio, which can give your credit score a boost. A personal loan can impact your credit score in both positive and negative ways.

Example Debt Consolidation with Personal Loans

Below is a sample fact pattern and debt consolidation scenario using a personal loan.

John Smith, age 30, lives and works in Miami Florida. John has three credit cards with the following open balances, interest rates, and minimum monthly payment amounts:

  • Card 1: Balance of $3,000, interest rate of 18%, monthly minimum of $75.
  • Card 2: Balance of $1,800, interest rate of 20%, monthly minimum of $48.
  • Card 3: Balance of $4,000, interest rate of 15%, monthly minimum of $90.

Each credit card calculates the minimum amount due as the monthly interest expense plus 1% of the outstanding principal balance. John’s total minimum monthly payments are $213.

John finds an offer to receive a personal loan of up to $9,000 at an interest rate of 16%. The loan has an origination fee of 2%, which is deducted from the loan amount. If John borrows the total $9,000, he must pay $218.86 each month for 60 months to completely pay off the loan.

John decides to accept the offer. He applies for the full $9,000 loan at 16% interest. The loan origination fee of $180 (i.e., $180 is 2% of $9,000) is deducted from the loan amount, so John receives a cash deposit into his bank account of $8,820.

John uses these new funds to pay off the principal amount of each credit card. He uses $8,800 to pay off all three cards (i.e., $3,000 + $1,800 + $4,000). John has $20 remaining from the loan, which he leaves in his bank account.

Although John’s monthly payment is $5.86 higher than before ($218.86 versus $213), he has consolidated the payments into a single monthly payment. In addition, the 16% fixed interest rate is lower than at least two of the three credit cards, so he will save on interest expenses in the long run.

Over the course of the loan, we will have paid $13,131.60 to pay off a $9,000 loan. His total interest expense paid is $4,131.60.

How does the total interest compare to not consolidating the debts?

Assume that John wants to calculate what his total payments and interest expense would be over the 60 month period if he decided to not consolidate the debts using a personal loan. The figures would look like the following:

  • Card 1: Make a payment of $76 per month for 5 years, debt paid off in 60 months. Total interest expense paid of $1,489.
  • Card 2: Make a payment of $48 per month for 5 years, debt paid off in 60 months. Total interest expense paid of $985.
  • Card 3: Make a payment of $95 per month for 5 years, debt paid off in 60 months. Total interest expense paid of $1,627.

Over the same 60 month period, he will have paid $13,140 ($219 per month times 60 months) to pay off $8,800 of credit card debts. The total interest expense paid is $4,101.

Notice how the total interest expense and total cash paid is quite similar whether he uses the personal loan consolidation or keeps the debts separate. This assumes, however, that the interest rates on each of your credit cards remains fixed throughout the 60 month period. Although the amounts are quite similar, John decides the debt consolidation still makes sense because he is combining everything into one fixed monthly payment with only one lender, which he feels will remove a lot of stress from his life.

What’s the Verdict on Personal Loans?

Using a personal loan to consolidate credit card debt into one monthly payment can be a smart financial move, especially if you can secure a lower interest rate and simplify your repayment plan.

It can help you save money, reduce financial stress, and offer a clear path to becoming debt-free. However, it’s important to evaluate your personal financial situation, shop for the best loan terms, and commit to healthy financial habits moving forward. Make sure to create a sensible monthly budget to better track your income, expenses, and debt payments.

With the right approach, debt consolidation can be a valuable step toward paying off your debts and increasing your FICO score.