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Using personal loans for a fresh start

Patricia Babalis avatar
Patricia Babalis
- 3 min read
Using personal loans for a fresh start

If you’re battling an escalating credit card bill, a personal loan could provide a low cost solution by slashing the high interest rates often attached to credit card debt.

Our average credit card debt is now over $4,000, and plenty of cardholders face serious difficulty bringing their balance under control. While there are many zero interest balance transfer deals on offer by credit card providers, if you can’t pay off the balance in the introductory period you could end up getting hit with even higher interest rates than you started with.

This is where a personal loan comes in.

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To see how this works let’s consider a cardholder – Mike. He currently has an outstanding debt of $5,000 on a credit card charging 15 percent. If he sticks to the minimum monthly repayments (set at 2 percent of the outstanding balance), it will take Mike a staggering 32 years to pay off the card in full, and this assumes he doesn’t add to the card balance!

During this time Mike will pay total interest of around $7,800. Mike could refinance with another card offering 0 percent interest for five months on balance transfers. To clear his card debt during the interest-free period, Mike would have to repay around $830 each month. For many of us that’s a tall order, and any balance remaining after six months could be slugged with rates applicable to cash advances – up to 19 percent.

Instead Mike opts for a five-year personal loan charging a rate of 14 per cent, which is achievable through a number of lenders. His monthly repayments are $116, and after five years Mike’s total interest bill would be about $1,980.

The beauty of the loan is that Mike’s repayments are fixed, making them easier to budget for, and he knows exactly when he will be debt-free giving him a target to work towards.

Here’s the interesting thing. If Mike chose to make the same monthly repayments of $116 on his credit card, he would clear the debt in exactly the same time – five years. But his overall interest cost would be $2,226, about $246 more than the personal loan. The downside of this option is that it requires the self-discipline to keep up voluntary extra payments. If the interest rate on Mike’s card rises in the interim, he could face even higher interest charges.

For many people, simply knuckling down and paying off their card is the easiest way to clear the debt. But if you’re battling a rising tide of credit card debt, a personal loan is a useful tool to get you on track and back in the black.

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Disclaimer

This article is over two years old, last updated on February 8, 2010. While RateCity makes best efforts to update every important article regularly, the information in this piece may not be as relevant as it once was. Alternatively, please consider checking recent personal loans articles.

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