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Should I Pay Off Credit Card Or Personal Loan First

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The Ascent’s Best Personal Loans For 2022

#AskSusie – Should I Pay Off My Credit Card or Loan Debt First?

The Ascent team vetted the market to bring you a shortlist of the best personal loan providers. Whether you’re looking to pay off debt faster by slashing your interest rate or needing some extra money to tackle a big purchase, these best-in-class picks can help you reach your financial goals. on The Ascent’s top picks.

How To Pay Off Credit Card Debt With A Personal Loan

If your balance is high, a personal loan may be better for paying off credit card debt. Personal loans tend to carry a lower interest rate than credit cards, which can help make your payments more affordable. While there are no hard-and-fast rules, several factors will determine whether you should opt for a personal loan to pay off credit card debtand which kind of loan. One factor is how much debt you have to transfer. Lenders typically set a $1,000 to $5,000 minimum for personal loans.4 Another factor is your credit score, which could play a deciding rolefrom the interest you pay to whether you can even qualify for a loan. Some lenders set the minimum score as low as 525, but others require a higher credit rating.5 Your debt-to-income ratio will also be examined. Secured loansusually home equity loansare normally easier to get, with lower interest rates and higher borrowing limits than unsecured loans. Using your home as collateral lowers the risk to the lender but raises yoursyou could lose the roof over your head if you default.6 Approvals for unsecured loans, the more common type of loan for paying off credit card debt, are based on available financial data and credit scoring.

Can You Pay Off Debt And Save

It is possible to pay off debt while also saving money, but it requires strategy, planning, and streamlining your spending habits.

The first step is to review your budget to see how much money you’re paying toward debt each month. Is there a way to make your debt less expensive so you can pay it off more efficiently? Transferring high-interest credit card debt to a new card with a 0% APR or refinancing student loans, for example, could reduce interest charges and help you pay more toward the balance owed.

Next, see if it’s possible to free up money by cutting back on certain expenses or eliminating them altogether.

With the money you squeeze out of your budget, whatever the amount, decide how much of it should go to debt and how much to saving. For example, if you have an extra $300 to work with and a goal of creating an emergency fund, you might put $200 toward saving and $100 toward debt, which will give you a savings cushion of $2,400 at the end of the year . Or maybe you have a high-interest credit card, which uses the idea of compound interest against you, so you put $250 each month toward paying it off, and the remaining $50 goes into savings. Whatever you decide, putting your money to work will pave the way for your financial freedom.

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You Could Boost Your Credit Score

While taking out a personal loan triggers a hard credit check and temporarily dings your credit score, a personal loan could impact your credit score positively in a number of ways.

Taking out a personal loan increases your credit mix, which makes up 10% of your score. It shows creditors and lenders that youre responsible with money by carrying many different types of credit and debt.

Youll also lower your credit utilization by paying down your debt. Your credit utilization is the ratio of how much credit youre using vs. how much credit is available to you. If you pay off your credit cards, your utilization will go down to 0%. Under 30%and ideally under 10%is considered great credit utilization and can help you improve your score.

Should You Pay Down Debt Or Save

What Debt Should You Pay Off First? (Highest Interest ...

Paying off debt and saving money for emergencies are both necessary to achieve good financial health. If you have a limited budget, you might be wondering which one you should tackle first. Understanding the benefits of both can help you create an individualized plan for mastering your money and help you reach your financial goals

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Stop Using Your Card If Youre Carrying A Balance

If you feel the need to raise your credit score, my guess is that you are maxing out your cards and not paying down the principal on your other loans.

To lower your card balances, it is important to not use any cards on which you are carrying a balance. New purchases accrue interest from the minute you make them if you are using a card with a balance. So continuing to pile on high interest debt will make it much more difficult to get your debt down and your score up.

Since you seem to be concerned about your score , please dont lose sight of what is most important here. That is your payment history. So just remember that as you focus on a strategy, you must be sure to pay at least the minimum on all of your other accounts and pay them on time.

Making payments on time and as agreed is going to have the most impact on your score. I suggest that you set a goal of a date by which you can reasonably be expected to pay off your debts.

This works much better than just trying to do the best you can from paycheck to paycheck. Then divide up the payment so it reduces the highest interest debt faster, while at the same time allowing you to keep up some payments on the others.

See related: What happens when you miss a credit card payment?

Alternatives To Using A Personal Loan To Pay Off Credit Card Debt

Using a personal loan may not be the only way to pay off credit card debt, so you should also consider alternatives. For example:

  • If you can qualify for a 0% balance transfer credit card, you may be better off doing so. You may be able to transfer the existing balances of your credit cards to a new balance transfer card that charges 0 percent interest for a set amount of time. Just make sure you can pay off the balance before the 0 percent promotional rate expires. Also, make sure you understand the differences between personal loans and credit cards.
  • You may want to use a home equity loan or home equity line of credit if you have a lot of equity in your home. A home equity loan or line of credit likely will have a lower interest rate than a personal loan. But, be aware youre putting your house at risk, so dont do this unless you can definitely pay back what you owe. Its also worth pointing out that interest on a home equity loan or line of credit is not deductible.

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Highest Credit Utilization First

If you’re planning to apply for a loan in the future, it’s crucial to get your credit score as high as possible. One of the major factors that determines your credit score is your . This is a measure of how much credit you’re using versus the total amount available to you. For example, if you have a $10,000 credit limit and you typically charge about $5,000 to it each month, your credit utilization ratio for that card is 50%. Ideally, lenders want to see a credit utilization ratio of less than 30%, and the lower the better.

If the balances on your credit cards exceed 30% of your credit utilization ratio, this may encourage you to pay off these debts before the others, even if other debts have higher balances or interest rates. This will help to boost your credit score, which can, in turn, help you secure lower interest rates on future loans.

One Exception: When The Loan Is A Payday Loan

Should I Take Out Student Loans To Pay Off Credit Cards?

Lenders offer payday loans as a short-term fix for consumers when cash is tight. Theres no credit check involved, and you can usually be approved for a payday loan quickly. But this easy-to-get money comes with a heavy price, usually in the form of exorbitant fees and triple-digit interest rates.

Always prioritize getting rid of payday loans. Heres why:

  • Its best to pay off your highest interest rate debts first. Even if you think you have a high rate on your credit card, payday loans are still worse. The interest on a payday loan can translate to an APR of 390% and sometimes as high as 600%.

  • Payday loans can lead to a debt spiral. If you can’t pay in full on the first payday, a new finance charge is added and the cycle repeats. Within a few months, you could end up owing more in interest than the original loan amount.

  • Unlike credit card companies, most payday loan lenders wont let you consolidate your debt.

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Pay Off Your Credit Cards

You can apply for a loan of up to $45,000 sometimes higher under special circumstances and once the money arrives in your account, its yours to spend. Divide the funds across all of your credit card balances until theyre at zero. Once thats done, take a moment to enjoy being free of credit card debt.

You May Have Smarter Money Options

If your personal loans interest rate is lower than the rates youre being charged on other types of debt, your money may be better spent elsewhere. Instead of paying off your personal loan early, you could focus instead on paying off higher-interest debt, like a credit card balance, which could save you more in the long run. You could also consider beefing up your retirement plan contribution at work in order to be eligible for an employer match or contributing money to a high-yield savings account. And of course, before making changes to your monthly contributions or paying off a personal loan early, check your bank accounts and make sure you have the funds to cover both your anticipated monthly expenses and unexpected emergencies. Preparing for the future could save you a whole lot of stress.

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Pros Of Prioritizing Savings

On the other side of the equation, there are several advantages to getting a head start on saving:

  • The sooner you begin, the more time you have to take advantage of compounding interest.
  • You can work toward your financial goals on your own timeline, versus having to wait until your debt is repaid.
  • Having some easily accessible savings can help you avoid accumulating new debt if an unexpected expense pops up.

Perhaps the best reason to apply money-saving tips to your financial life as early as possible is compound interest. Compound interest refers to the interest earned on your interest, either in a savings account, money market account, CD, or investment account. The more time your money has to compound, the more it can grow.

Waiting even five or 10 years to start saving can make a significant difference in how much you’ll accumulate over time. For example, say you begin contributing $5,500 a year into an individual retirement account at age 25. If you continue to save that same amount until age 65, earning a seven percent return, you’d have $1.17 million saved for retirement. However, if you wait until age 35 to start, your retirement nest egg would grow to about $556,000.

Getting a head start on saving can also help you achieve other long-term goals, such as buying a home, traveling, or jump starting your kids’ college fund.

What Is A Prepayment Penalty And Why Do They Exist

What Debt Should I Pay Off First?

A prepayment penalty is a fee that some lenders charge when borrowers pay off all or part of a loan before the term of the agreement ends. In effect, prepayment penalties dissuade the borrower from paying off a loan ahead of schedule, which causes the lender to miss out on interest income. The best way to avoid a prepayment penalty is to work with a lender that doesnt charge one. At LendingClub, for example, you can make extra payments or pay off your loan in full at any time with no additional charges.

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Round Up Your Monthly Payments

Round up your monthly payments to the nearest $50 for an effortless way to shorten your loan. For example, if your auto loan costs you $220 each month, bring that number up to $250. The difference is too small to make a tangible dent in your budget, but large enough to knock a few months off the life of your loan and save you a significant amount in interest.

For a potentially even bigger impact, consider bumping up your payments to the nearest $100.

Saving Money On Interest

The best reason to pay off loans and other debts early is that it can save you money in interest payments. The only advantage of interest is that it allows you to pay more slowly and more manageably.

Interest doesnt make the item you bought more valuable. The longer you pay, the more it costs. So, the quicker you pay off your loan, the less you ultimately spend on your purchase.

This is especially the case with credit cards or other high-interest debt. Its a terrible idea to make only the minimum monthly payment. Paying off such debt is a sure way to save money. A good rule of thumb is the quicker you can pay for something, the less it ultimately will cost.

Lets say you borrowed $25,000 for five years at 5% interest. If you pay on time for the full 60 months, youll pay $3,307 in interest. Paying it off early can eliminate some of that interest assuming you are paying simple interest, which most loans are.

A simple-interest loan has you pay interest based on what you owe at given time. The interest on that $25,000 loan would total only $2,635 if you paid it off in four years, a savings of $672.

However, if you have a precomputed interest loan, the amount of interest you pay is fixed regardless of when you pay it off. Some loans have prepayment penalties. Check the details before making a move.

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What To Like About Using A Personal Loan To Pay Off Credit Cards

End your reliance on revolving debt: Unlike a credit card, a personal loan is an installment loan, with fixed payments over a fixed repayment term. By switching to a personal loan, you can ditch the plastic in your wallet, which might help you improve spending habits.

Repay your debt at a lower APR: Credit cards carry some of the highest interest rates among consumer financing options. With good credit or a creditworthy cosigner, you could qualify for a lower . That would result in potentially significant savings, since more of your monthly payment would go toward the principal of your outstanding balance, not the accruing interest.

Have a single monthly payment: If youve racked up debt on multiple credit cards, your head might be spinning with all the different accounts and their individual payment requirements. Consolidating this debt with a personal loan, though, would give you a single monthly payment to a single lender. Sometimes, simpler is better.

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Should I take a personal loan to pay off my credit cards?

SoFi personal loans have low interest rates and fixed monthly payments, which can be helpful when paying off high-interest debt. The online application is quick find your rate in just two minutes without any commitment to continue. If youre approved, the funds are deposited directly into your account.

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There Are Multiple Approaches To Debt Repayment

There are four main approaches to debt repayment. Ill discuss three in more detail, but the other I will just mention in passing because its not an effective strategy.

Debt repayment strategies can be divided into two main categories: Dividing your payments equally across all your debts, or focusing on a single debt at a time while paying the minimum on all your others.

According to research by the Harvard Business Review, the tactic of applying equal payments to all debts is less effective. In fact, people who tried the various methods found that focusing most of your efforts on one debt at a time help pay off debts 15% faster.

The other category, however, comprises three separate approaches: Paying down debts based on the balance, based on the interest rate, or based on the available credit. There are benefits and drawbacks to each method, but Ill go over each one.

The important thing to remember is that if you want to pay down your loans as quickly as possible, then the key is chipping away larger chunks of one debt while continuing to make the minimum payments on all your other debts.

How To Decide Whether To Use A Personal Loan To Pay Off Credit Cards

Ultimately, every borrower needs to decide on a debt repayment approach thats right for their needs. There are, however, some situations when it typically makes sense to use a personal loan to repay your credit card debt.

First off, it may make sense to take out a personal loan to pay off your credit card debt if you can get a loan with a lower rate. If all your cards charge 15 percent interest or greater and you can get a personal loan at 8 percent, for example, then the personal loan typically makes financial sense.

If youre not confident that you wont overspend on your credit cards again as soon as youve paid off the balance with a personal loan, think twice about whether your financial situation would improve or get worse. Since your credit cards will no longer have high balances, you will be free to spend on them again, but that is clearly not a good idea.

Be sure youre living on a budget and living within your means so youre ready to consistently make your personal loan payments and spend responsibly.

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