How To Use a Personal Loan To Pay Off Debt

Using a personal loan is one of the most effective methods for tackling a mound of high-interest debt. Learn how to use this strategy to pay off debt, save on interest, and lower your monthly payment.

Using a personal loan to pay off debt

A personal loan is an unsecured debt that can be used for almost any purpose, including debt consolidation. It has a fixed interest rate, fixed monthly payments, and a repayment period that typically lasts one to seven years. 

Personal loan interest rates tend to be much lower than credit card interest rates, which is why using a personal loan to pay off credit cards can save you a lot of money. 

As of August 2024, the average interest rate on a two-year personal loan was 12.33%, while credit cards averaged 21.86%, according to the Federal Reserve. 

Using a personal loan to pay off or consolidate debt works like this: 

1. Find a personal loan with an interest rate lower than the rate on your current debt.
2. Apply for a personal loan to consolidate debt into one monthly payment. 
3. If you’re approved, sign the loan documents, receive money, and use it to pay off each debt. Some lenders can pay your creditors directly. 
4. Pay the loan as agreed until the loan term ends.

The cost of using a personal loan

A personal loan could help you pay off credit card debt, but what’s the true cost of using one? 

Let’s say you have two credit cards you’d like to pay off over three years using a personal loan. 

1. Balance of $5,000 and 27.99% APR
2. Balance of $7,000 and 25.99% APR

To pay off both balances, you’d need a personal loan for $12,000. You’ve prequalified for a 12.50% APR for three years. Using our personal loan calculator, this is what you’d pay for a personal loan compared to keeping the credit cards and increasing your monthly payments.

Credit cards don’t have a set-in-stone end date for payments, but you can attempt to pay them off on your timeline. If you leave the balances on the credit cards, you’d end up paying $88 more per month and $5,595 in interest overall. Using a personal loan in this scenario saves over $3,100 in interest. 

Other financing options like a home equity loan or a 401(k) loan could offer lower rates than a personal loan, but there’s also less flexibility and higher stakes. 

Home equity loans require you to own a home with equity in it. Rather than using the equity to make improvements and increase its value, you’re using it for credit card consolidation. This could mean putting off future renovations or delaying a home sale. 

Borrowing with a 401(k) loan has a similar appeal, except your retirement is on the line. A 401(k) loan removes that money from your retirement account and cuts into your retirement savings. Plus, there are heavy tax penalties for not paying these loans back. 

Pros and cons of using a personal loan to pay off debt

In most cases, paying off your debt with a personal loan puts you in a better financial position. The disadvantages might push you to reorganize your finances. 

Pros

• Lower fixed interest rate: On average, personal loans have lower interest rates than credit cards. The interest rate also doesn’t change, unlike credit cards. That means you’ll likely pay less over time. 
• Fixed payment and repayment date: Instead of a fluctuating payment, you’ll have the same payment each month. Plus, you’ll know exactly when you’ll be done repaying the loan. 
• Pay off multiple cards with one loan: If you have multiple cards to pay off, this could help simplify your monthly bill routine by consolidating multiple debts into one payment.
• Faster payoff: Paying more toward the principal and less toward the interest helps you pay off debt faster and could cut years off your repayment timeline. 

Cons

• Loan origination fee: Some personal loans have fees attached. The most common is a loan origination fee. This ranges anywhere from 1% to 10%, though it could be higher, and could cut into how much you’re saving. 
• Higher monthly payment: The new payment on a personal loan is likely higher than the minimum payments on your credit cards. Make sure your new payment fits into your budget before accepting the loan.
• Available credit card balance: When paying off your credit cards with a personal loan, you gain more available balance to spend on your credit card. If you have trouble resisting the urge to spend more, it could be a problem. 

How to apply for a personal loan to pay off debt

Follow these steps to find the best personal loan for you. 

• Prequalify: Before settling on a final decision, you should weigh your options by prequalifying with multiple lenders. This process allows you to see what your potential annual percentage rate (APR) — which includes the interest rate plus fees — loan amount, and monthly payment could be without incurring a hard inquiry on your credit report. Prequalification is not an offer of credit, however, and the final rate you get from your lender could be higher.
• Choose the best loan option: Narrow down your choices to 2 or 3 and choose one with the best terms and lowest fees. Calculate how each option fits into your budget and make adjustments where needed. 
• Complete an application: After making the final choice, fill out an application with your personal information. The lender will then perform a hard pull of your credit. You could get a decision back within a few minutes or in about two business days, depending on the lender. 
• Receive funding: If you’ve been approved, you can choose between having the loan funds sent to your bank account to pay off debt on your own or having the lender pay your debts directly, if your lender offers it. If it’s the latter, you’ll need to enter payment details for each debt. 
• Begin repayments: After the debts have been paid off, it’s time to begin repaying your loan. Setting up automatic payments is the easiest way to make your payments on time. With some lenders, signing up for autopay even gives you an interest rate discount.

Learn More: How To Get a Debt Consolidation Loan

Other alternatives to pay off debt

Here are some alternatives to a personal loan.

• Debt avalanche or debt snowball methods: These two debt payoff methods pair well with a debt consolidation tool like a personal loan. Organize your debts by highest to lowest interest rate (for debt avalanche) or highest to lowest balance (for debt snowball). Pay as much as you can toward the highest interest rate debt or the lowest balance debt, while all others get minimum payments. When the first debt is paid off, add the payment for that to the next debt on the list and repeat. 
• 0% APR balance transfer card: This option involves transferring existing balances to a 0% APR card. By taking advantage of a 0% APR promotion, you can speed up your debt payoff and save money on interest. The drawback is that balance transfer credit cards resume the standard APR after the promotion ends. 
• Home equity loan: A home equity loan uses the equity within your home to finance a loan. Since these loans use your home as collateral, there’s less risk for the lender, so they often have lower interest rates compared to personal loans. However, if you default on the loan, the lender can seize your collateral. 
• 401(k) loan: Borrowing from your 401(k) pulls money from your retirement savings account at a low interest rate (usually the prime rate plus 1 percentage point to 2 percentage points). Payments come directly from your paycheck, so repayment is automatic, but it could derail your retirement plans if you aren’t prepared to increase your retirement contributions. 

Read More:

• What Are the Requirements for a Personal Loan?
• What Credit Score Is Needed for a Personal Loan?
• How Much of a Personal Loan Can I Get?
• 401(k) Loan vs. Personal Loan
• Best Personal Loans for Fair Credit
• Best Personal Loans for Good Credit
• Best Personal Loans With a Cosigner