Should you take out a personal loan to pay off credit cards?

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People talk all day long about their workouts, favorite apps and their love lives, but bring up the subject of money, especially credit card debt, and suddenly everyone clams up.

Just because we don’t talk about debt doesn’t mean it’s not an issue. After all, the average American household carrying a credit card balance has over $5,500 in credit card debt in 2021. But how do you pay off credit card debt? One method to consider: taking out a personal loan.

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Related: How to get approved for a personal loan

How Using a Personal Loan to Pay Off Credit Card Debt Works

Personal loans are a type of unsecured loan that a borrower can take out for almost any purpose, including paying off credit card debt. Loan amounts can vary by lender and will be paid to the borrower in one lump sum after the loan is approved. The borrower then pays back the loan — with interest — in monthly installments that are set by the loan terms. 

Many unsecured personal loans come with a fixed interest rate that won’t fluctuate or change over the life of the loan. An applicant’s interest rate will be determined by a set of factors, including their financial history, credit score, income, and other debt, among other factors. Typically, the higher an applicant’s credit score the better their interest rate will be, as they may be seen as a less risky borrower. Lenders may offer individuals with low credit scores a higher interest rate, presuming they will be more likely to default on their loans.

When using a personal loan to pay off credit card debt, the loan proceeds are used to pay off the cards’ outstanding balances, consolidating the debts into one loan. Ideally, the new loan will have a much lower interest rate than the credit cards. Consider that the average credit card interest rate is about 16%, while the average personal loan rate is about 9.5%, according to the Federal Reserve. By consolidating credit card debt into a personal loan, a borrower’s monthly payments can be more manageable and cost considerably less interest. 

Finally, using an unsecured personal loan to pay off credit cards also has the benefit of ending the cycle of credit card debt, without resorting to a balance transfer card. Balance transfer credit cards are just credit cards that usually have an introductory offer of a low rate (or a 0% rate) on balance transfers to the new card. 

This might seem like an appealing offer. But if the balance isn’t paid off before the promotional offer is up, the cardholder could end up paying an even higher interest rate than they started with. Balance transfer cards often charge a balance transfer fee, which could ultimately increase the total debt.

Taking Out a Loan to Pay Off Credit Card: Pros and Cons

While on the surface it may seem like taking out a personal loan to pay off credit card debt could be the best solution, there are some potential drawbacks to consider as well. Here’s a look at some of the pros and cons.

Pros

  • Lower interest rate: Personal loans may charge a lower interest rate than high-interest credit cards. Consider the average interest rate for personal loans is under 10%, while credit cards charge over 16% on average.
  • Streamlining payments: When you consolidate credit card debt under a personal loan, there is only one loan payment to keep track of each month, making it less likely a payment will be missed because a bill slips through the cracks.
  • Pay off debt sooner: A lower interest rate means there could be more money to direct to paying down existing debt, potentially allowing the debtor to get out from under it much sooner.
  • Credit score boost: It’s possible that taking out a personal loan could boost the borrower’s credit score by increasing their credit mix and lowering their credit utilization by helping them pay down debt.

Cons

  • Lower rates aren’t guaranteed: If you have poor credit, you may not qualify for a personal loan with a lower rate than you’re already paying. In fact, it’s possible lenders would offer you a loan with a higher rate than what you’re paying now.
  • Loan fees: Lenders may charge any number of fees, such as loan origination fees, when a person takes out a loan. Be mindful of the impact these fees can have. It’s possible they will be costly enough that it doesn’t make sense to take out a new loan.
  • More debt: Taking out a personal loan to pay off existing debt is more likely to be successful when the borrower is careful not to run up a new balance on their credit cards. If they do, they’ll potentially be saddled with more debt than they had to begin with.
  • Credit score dip: If closing the now-paid-off credit cards after taking out a personal loan is a temptation, perhaps reconsider doing so. Closing credit accounts that have been on a person’s credit report for some time could shorten their length of credit history and possibly negatively affect their credit score.

So You’ve Decided to Apply for a Personal Loan to Pay Off a Credit Card. Now What?

The steps for paying off a credit card with an unsecured personal loan aren’t particularly complicated, but having a plan in place is important.

1. Getting the Whole Picture

It can be scary, but getting the hard numbers — how much debt is owed overall, how much is owed on each specific card, and what the respective interest rates are — can give a sense of what personal loan amount might be helpful to pay off credit cards.

2. Searching Personal Loan Options

These days, most — or all— personal loan research can be done online. A personal loan with an interest rate lower than the credit card’s current rate is an important thing to look for. Origination fees, which can add to a person’s overall debt and possibly throw off their payoff plan, is another thing to watch out for.

3. Paying Off the Debt

Once an applicant has chosen, applied, and qualified for a personal loan, they’ll likely want to immediately take that money and pay off their credit card debt in full after they receive the loan proceeds.

The process of receiving a personal loan may differ. Some lenders will pay off the borrower’s credit card companies directly, while others will send the borrower a check that they’ll then have to deposit and use to pay off the credit cards themself.

4. Hiding Those Credit Cards

One potential risk of using a personal loan to pay off credit cards is that it can make it easier to accumulate more debt. The purpose of using a personal loan to pay off credit card debt is to keep from repeating the cycle.

Consider taking steps like hiding credit cards in a drawer and trying to use them as little as possible. 

5. Paying Off Your Personal Loan

A benefit of using a personal loan to consolidate credit card debt is that there is only one monthly payment to worry about instead of several. Not missing any of those loan payments is important — setting up a monthly reminder or alert can be helpful.

6. Applying for a Personal Loan to Pay Off Credit Cards

With online applications, the process for getting a personal loan can be quick and easy, and some lenders may provide live customer support. Applying online typically doesn’t take more than a few minutes. And there are more options than ever with innovative fintech startups doing what they can to make the process of refinancing your credit card debt quick and easy. 

Again, there’s also the potential for saving. Of course, everyone’s situation varies, but you can use a credit card interest calculator or personal loan calculator to do the math on your own.

Budgeting Debt Payoff

Before embarking on paying off credit card debt, a good first step is pulling together a budget, which can help a person better manage their spending. And they might even find money in their budget to put towards that outstanding debt. If a person has more than one type of debt (for instance, a mortgage, student loan and maybe a car loan), they may want to think strategically about how to tackle them.

Some finance gurus recommend taking on the debt with the highest interest rate first, a strategy known as the avalanche method. As those high-interest-rate debts are paid off, there is typically more money in the budget to pay down other debts.

Another approach, known as the snowball method, is to pay off the debts with the smallest balances first. This method gives a psychological boost, with small wins early, and over time can allow room in the budget to make larger payments on other outstanding debts. Of course, for either of these strategies, keeping current on payments for all debts is essential.

The Takeaway

High-interest credit card debt can be a huge financial burden. If a person is only able to make minimum payments on their credit cards, their debt will only increase, and they’ll find themselves in a vicious debt cycle. Personal loans are one potential way to end that cycle, as a tool to pay off debt in one fell swoop and hopefully replace it with a single, more manageable loan. 

Remember, however, that personal loans aren’t for everyone. While they typically have lower interest rates than credit cards, they are still debt and should be considered carefully and used responsibly.

Learn more:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

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Paying tax on personal loans

Paying tax on personal loans

There are plenty of reasons to take out a personal loan, many of which are totally financially savvy. For instance, you might be thinking about consolidating high-interest debts like credit card balances.

Or you might plan to borrow in order to repair the roof or remodel the kitchen to help increase your home value.

Maybe you’re considering taking out an unsecured personal loan to pay for an unexpected medical bill.

Whatever the case, personal loans can be a useful tool to help you cover expenses and stabilize your finances. Plus, they may be easier to qualify for than other types of loans and come with less red tape.

But as in all things finance, Uncle Sam wants his cut, too. So, as you consider your borrowing options, you might wonder about how taxes work on unsecured personal loans.

For instance, you may question if a personal loan can be taxed as income and whether you can get a personal loan interest tax deduction.

If you are trying to decide between several types of financing, reviewing the potential tax implications of each borrowing option can help you figure out a financing strategy that fits your situation.

In this article, we’ll cover things you’ll likely want to know about when it comes to tax on personal loans, including whether personal loans qualify as income, and whether the interest on them is tax-deductible.

Plus, we’ll cover some scenarios that can come with tax benefits that might apply to you and your loan. This way you’ll be armed with helpful knowledge useful when making the right borrowing decisions for you.

It is, however, important to note that we’re not tax experts. For any tax-related questions or advice, you’ll want to consult a tax accountant — and not a blog post like this one.

Related: A guide to understanding your taxes

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When you take out a personal loan, your lender agrees to loan you a particular amount, and you agree to pay that loan back over a set period of time with interest.

Which is actually good news on the tax front: Even though it seems like a windfall that you could be taxed on, it isn’t. Since you are agreeing to pay that money back, it does not qualify as income the way wages from a job would.

The only instance when money from a personal loan can be taxed as income is if your lender agrees to forgive the loan. Loan forgiveness can be a rare occurrence and typically occurs under the following circumstances:

  • You are renegotiating the terms of a loan you are struggling to repay.
  • You’re declaring bankruptcy.
  • Your lender decides to stop collecting on the loan.

This is called a cancellation of debt, and it can carry tax liabilities since you’re receiving the remainder of the loan without the caveat that you’ll be paying it back.

For instance, let’s say you’ve taken out a $10,000 personal loan and have paid back $8,500 of it when the debt is forgiven or cancelled. The remaining $1,500 that you’d no longer have to pay back can be taxed as income during the year it is cancelled.

Typically, your lender will send you a tax form (a 1099-C) stating the amount cancelled, which you must subsequently report to the IRS on your tax return. Again, this is a very, very rare circumstance, so it’s nothing to count on.

Bottom line: In most situations, personal loans are not taxable as income — but if your loan is cancelled or forgiven, the remainder of the loan amount that you’ve yet to repay can be taxed the same way regular income is.

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The IRS regulates which types of loans come with tax deductions. While there are some types of loans that have tax-deductible interest, unfortunately, personal loans don’t fit into that category.

The interest you pay on personal loans is not tax deductible. So, if you take out a loan and pay a few hundred dollars in interest over the course of your repayment, that’s not a cost that will reduce what you owe in taxes come April.

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Although personal loan interest isn’t tax deductible, there are many other types of loans that do carry special tax benefits and interest deductions. For instance, student loan interest and mortgage and property loan interest can be deductible up to certain amounts, although there are some restrictions.

Michael Krinke

You may deduct up to $2,500 of interest on qualified student loans or the full amount you paid during the tax year,whichever is the lesser.

However, this deduction is gradually phased out as your income increases, and it is not available if you or your spouse can be claimed as a dependent on someone else’s tax return.

fizkes / istockphoto

In the majority of cases, you can deduct every cent of interest you pay on your home mortgage. The loan must be secured (that is, your home must be offered as collateral on the loan; this deduction will not work if you use an unsecured personal loan to cover some or all of the cost of your housing).

As of 2018, you can deduct the interest on up to $750,000 of a qualified home loan if married and filing jointly, or up to $375,000 of qualified debt for single filers. (These limits were lowered from $1 million under the Tax Cuts and Jobs Act of 2017, but if you signed your mortgage before December 16, 2017, you’re grandfathered into the previous limit.)

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Some business expenses are tax deductible, and that includes the interest you pay on loans taken out for business-related purposes. However, you can also deduct business expenses you pay for using an unsecured personal loan, which we’ll dive into a little bit more deeply in the next section.

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Although staying debt-free is standard financial advice, sometimes taking out a personal loan can be a smart money move, especially if you’re already dealing with high-interest forms of debt, such as consumer credit cards.

Debt consolidation, a financial tactic, which involves taking out one large loan to cover multiple smaller debts, may reduce your credit utilization ratio and potentially help you save money on interest, not to mention make your bill-paying schedule a whole lot simpler.

For example, maybe you owe $8,000 on one personal credit card and $4,500 on another credit card, both with high (and different) interest rates. With multiple bills coming due at different times of the month, chances are you’re only paying the minimum required amount on each of them, which means you’re paying them off slowly and paying a lot of interest.

However, if you were able to qualify for and take out a $12,500 personal loan at lower interest rate, you’d only have to worry about one payment date, and you might even save money on the sky-high credit card interest rates, which could simplify both your life and your finances.

Personal loans (home improvement loans) can also help you get started on major home renovations, which may increase the value of your house and help you earn back your investment in the form of equity.

Learn more:

This article
originally appeared on 
SoFi.com and was
syndicated by
MediaFeed.org.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SoFi Loan Products
SoFi loans are originated by SoFi Lending Corp (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636  Opens A New Window.. For additional product-specific legal and licensing information, see SoFi.com/legal.

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