How to Use a Personal Loan to Pay Off Debt?

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Debt consolidation can save you money and help you pay off your balance faster. Learn how to use a personal loan to pay off debt. (Shutterstock)

Debt spiraling out of control can strain your budget, leaving you with little money left over after paying your monthly bills. If you manage multiple balances, a personal loan can be a valuable tool to help you pay off your debt.

Consolidating high-yield debt with a personal loan can save you money on interest and simplify your finances since you only need to keep track of one payment. understand how personal loans work can help you decide if it makes sense to use one to consolidate your debt.

Credible makes it easy to view your prequalified personal loan rates from different lenders, all in one place.

What is debt consolidation?

Debt consolidation combines several debts into a single personal loan or credit card. Depending on your creditworthiness, you may pay less interest and lower your monthly payments while making your debt easier to manage.

In general, a debt consolidation loan is an installment loan with a fixed interest rate and monthly payment. Most personal loans are unsecured, so you don’t need to provide any collateral. Your eligibility depends on your credit history, income and debt-to-income ratio, among other things.

How to Use a Personal Loan to Pay Off Debt?

To save money, you should only consider taking out a personal loan if the interest rate is lower than the rates on your existing debt.

You can take out a personal loan through a bank, credit union, or online lender. When you sign up with an online lender, they streamline the loan process so you can receive money quickly, often the same or next business day. Loan amounts vary by lender, but usually range from $1,000 to $100,000.

When you apply for a personal loan, the lender may ask you to indicate what you intend to do with the loan funds. Most lenders allow you to use a personal loan to consolidate debt, but it is essential that you understand the loan terms as some lenders may limit how you can use the money.

If the lender approves your personal loan, financing usually occurs in two ways if you use the loan for debt consolidation:

  • Flat rate payment — You will receive a lump sum as a direct deposit to your bank account that you can use if needed. You can then use the money to pay off all your existing debts.
  • Lender pays your creditors — Some lenders send direct payments to your creditors on your behalf.

If you’re paying off the debt yourself, you’re submitting the payout amount, not the minimum owed or statement amount. You want to make sure you bring your balance to zero. You then start to repay the new personal loan with one fixed amount per month.

Visit Credible to compare personal loan rates from different lenders, without affecting your creditworthiness.

Benefits of taking out a personal loan for debt consolidation

Here are some benefits of using a personal loan to reduce your debt:

  • Potentially save money — With good credit you may be eligible for a personal loan with a lower interest rate than what you pay on your credit card debt. The average interest rate on a 24-month personal loan in May 2022 was 8.73%, according to data from the Federal Reserve. This is significantly less than the 16.65% average interest rate for credit cards over the same period.
  • Can pay off debts earlier – Depending on the amount of debt you have, it can take years or even decades to pay off your card balances. But personal loans have fixed repayment terms with a specific payout date, so you know exactly when your balance hits zero.
  • Simplify your payments — Managing your debt is much easier when you only have to make one payment instead of trying to keep track of different due dates for all your accounts.

Disadvantages of taking out a personal loan for debt consolidation

As with any credit product, it is wise to consider its drawbacks before making a decision. Personal loans have a number of drawbacks, including:

  • May not get a lower interest rate – While personal loans generally offer lower interest rates than credit cards, you may not receive a lower interest rate if you: bad credit.
  • Come with fees – Check your loan terms for costs that could reduce your savings through a lower interest rate. Additional costs can include loan fees, late payments, and insufficient funds.
  • Potential for more debt — Debt consolidation can provide long-term benefits to your finances by paying off multiple credit cards and other debt accounts. But if you build up debt on those accounts again, you could end up with more than your original debt.

Other Debt Repayment Strategies to Consider

If a personal loan isn’t right for you, you can still pay off your loan principal faster — and save on interest charges — by making more than the minimum payments on your accounts. Also consider these other debt repayment strategies:

  • Debt avalanche method — The debt avalanche strategy focuses on paying off debt accounts with the highest interest rates first. Prioritizing your payments to eliminate high-interest debt first can help you save more on interest.
  • Debt Snowball Method — This strategy involves paying off credit accounts with the lowest balances first to take advantage of quick wins that build momentum and motivation.
  • 0% APR Balance Transfer Card — Transferring your debt to a balance transfer credit card with a 0% APR introductory period between six and 21 months is an effective way to pay off debt. With no interest charges dragging you down, all your payments during the promotional period go straight toward paying off your debt, minus any fees. Please note that if you still have a balance on you at the end of the promotional period, you will accrue interest at the card’s regular rate, which may be higher than a personal loan.

Whether it’s a debt consolidation loan, repayment strategy, or balance transfer credit card, getting rid of debt has its benefits. Living debt-free may give you less stress, more freedom, and the ability to focus more on building savings and wealth.

If you want to apply for a debt consolidation loan, Credible allows you to quickly and easily compare personal loan rates to find one that fits your needs.