When you’re dealing with high-interest debt, whether it’s from credit cards or other loans, finding an effective way to manage it can feel overwhelming. One solution that often pops up is using a personal loan to consolidate and pay off debt. But is this a smart financial move, or could it end up causing more harm than good?

The answer depends on various factors, including the terms of the personal loan, your financial habits, and the kind of debt you’re consolidating. To help you weigh the pros and cons, this article breaks down when using a personal loan to pay off debt makes sense and when it might not be the best choice.

What Is a Personal Loan and How Does Debt Consolidation Work?

A personal loan is a type of unsecured loan that you can use for various purposes, including consolidating debt. When you take out a personal loan, you receive a lump sum of money, which you then repay over time with interest. Debt consolidation involves using that lump sum to pay off multiple debts, leaving you with a single monthly payment instead of juggling several.

The main idea behind debt consolidation is to simplify your financial life and ideally reduce your interest rate. But while the concept sounds appealing, there are several factors to consider before committing to it.

The Pros of Using a Personal Loan to Pay Off Debt

1. Lower Interest Rates

Credit cards often have interest rates ranging from 15% to 25%, while personal loans generally offer lower rates, typically between 6% and 12% for borrowers with good credit. Consolidating debt through a personal loan could save you significant money in interest.

Example:

If you’re paying 18% interest on a $10,000 credit card balance, switching to a personal loan with an 8% APR could save you over $1,000 in interest over three years.

2. Simplified Budgeting

Managing multiple debts with different interest rates and due dates can be stressful. A personal loan consolidates these into one fixed monthly payment, making it easier to budget and track your progress.

3. Predictable Payments

With a personal loan, you’ll have structured repayment terms, such as a set monthly payment over a fixed number of years. Unlike credit cards, which allow you to carry a balance indefinitely, a personal loan has an end date, helping you stay on track to becoming debt-free.

4. Potentially Improve Your Credit Score

Paying off credit card debt with a personal loan can reduce your credit utilization rate, which is a major factor in your credit score. A lower utilization rate (ideally below 30%) can result in a score boost.

Pro Tip: Only see this benefit if you avoid accumulating new credit card debt after consolidating.

5. Opportunity to Reset Financial Habits

By consolidating debt and lowering monthly payments, you might create room in your budget to focus on building an emergency fund or saving for other financial goals. This could help you break the cycle of relying on credit cards for unexpected expenses.

The Cons of Using a Personal Loan to Pay Off Debt

1. Fees and Costs

Some personal loans come with origination fees, which are typically 1% to 8% of the loan amount. This fee is either deducted from the loan or added to your repayment balance. Borrowers may also incur prepayment penalties if they pay off the loan early.

Example:

Borrowing $10,000 with a 5% origination fee means you’ll only receive $9,500, but you’ll still owe $10,000.

2. Higher Interest for Suboptimal Credit

If your credit score isn’t great, you may not qualify for a lower interest rate. Some personal loans can have interest rates as high as 36%, rivaling or even exceeding credit card APRs.

3. Risk of New Debt Accumulation

Consolidating debt doesn’t erase it, and some people fall into the trap of accumulating new debt after paying off old balances. This creates a worse financial situation, as you now have both the new personal loan payment and additional credit card debt.

4. Fixed Repayments May Lack Flexibility

Unlike credit card payments, which can vary depending on what you can afford, personal loan payments are fixed. If you experience a financial hardship, the rigid repayment schedule may cause additional stress.

5. Doesn’t Address Underlying Issues

A personal loan can help consolidate debt, but it doesn’t solve the root causes of overspending or poor financial habits. Without addressing these issues, you may find yourself in debt again.

When Does Using a Personal Loan Make Sense?

A personal loan could be a good option for paying off debt in the following scenarios:

  • You Have a High Credit Score: If you qualify for a loan with an interest rate significantly lower than your current debt, consolidating makes financial sense.
  • Your Monthly Payments Are Unmanageable: Consolidating debt can lower your monthly payments, freeing up cash flow in your budget.
  • You’re Committed to Not Adding New Debt: If you’re disciplined about avoiding further credit card spending, a personal loan can help you make headway in becoming debt-free.
  • You Want a Clear Debt-Free Timeline: The structured repayment term of a personal loan provides a clear end date, helping you stay motivated.

When to Think Twice About Using a Personal Loan

Using a personal loan to pay off debt might not be the right move if:

  • You Have a Low Credit Score: If you can’t qualify for a better interest rate than your current debts, consolidating won’t save you money.
  • You Struggle with Overspending: If you’re not ready to stop relying on credit cards, a personal loan might worsen your financial situation.
  • The Fees Outweigh the Savings: Consider how much you’ll gain in savings versus fees like origination charges and prepayment penalties.
  • Your Loan Term Extends the Debt Timeline: While lower monthly payments sound appealing, a longer repayment term can result in higher total interest over the life of the loan.

Example: A $10,000 loan at 8% interest with a 5-year term costs $2,166 in interest, compared to $1,027 with a 3-year term.

Tips for Successfully Using a Personal Loan for Debt

If you decide a personal loan is right for you, follow these tips to maximize its benefits:

1. Compare Loan Offers

Shop around for the best rates using banks, credit unions, or online lenders. Prequalification tools can give you rate estimates without affecting your credit score.

2. Do the Math

Calculate the total cost of consolidating, including interest and fees. Ensure your savings outweigh the costs.

3. Stick to a Budget

Create a budget to manage your monthly loan payments while avoiding overspending. Apps like YNAB or Mint can help you stay on track.

4. Plan for Emergencies

Build a small emergency fund before consolidating, so you can handle unexpected expenses without dipping back into credit.

5. Address Financial Habits

Identify habits contributing to your debt, such as overspending or lack of budgeting. Working on these behaviors ensures you won’t fall into the same cycle.

Pro Tip: Consider taking a free financial education course or meeting with a credit counselor for additional support.