Things you must keep in mind while availing personal loans for repaying credit card dues
With credit cards in our wallets, we have the option of spending even if we don’t have any funds at our disposal. However, we mistakenly consider credit cards to be an extension of our income and thus, end up spending more than what we can repay. Worse still, the outstanding balance continues to grow at a rapid pace because of high rate of interest levied by the credit cards (this can be as high as 45%). This is when we explore options to come out of the burgeoning debt trap. Personal loan is often hailed as one of the most viable options to pay off credit card dues.
Why you must consider availing personal loan to pay off your credit card dues
Low interest rates: The rate of interest on personal loans is significantly lower than the interest rate charged by credit cards. While interest rate on credit card outstanding can be as high as 45%, lenders charge 11.5-24% interest rate for personal loans.
Easier to manage repayments: With outstanding balances on two or more credit cards, you will have to keep track of multiple outstanding payment amounts and due dates in a month. On the contrary, taking a single personal loan to pay off multiple credit card balances consolidates the debt and reduces the hassle for the undisciplined lot among the credit card holders.
Flexibility in fixing the tenure and EMI: Personal loans also allow you the option of fixing the tenure of your loan according to your own repayment capacity. Unlike credit cards where the outstanding balance has to be paid at one go to avoid interest payment and penalties, the repayment of personal loan is made over a period of time, ranging from 1 to 5 years. This allows you to properly plan your repayment.
What you must keep in mind while availing personal loans for repaying credit card dues
Credit score: As personal loans are typically unsecured loans, lenders easily approve personal loans to people with high credit score. Otherwise, they charge a higher interest rate or may even reject the loan application. For this, you need to ensure that you keep paying the minimum amount due on your credit card. Else, it will show us as delayed payment in the records thereby affecting your credit score. Accumulating a credit card debt after repeatedly failing to pay the dues lowers your credit score, which in turn reduces the probability of availing personal loans at lower rates or even the approval of your loan itself.
Loan Tenure: Your loan tenure will play a major role in determining the size of your EMI. A longer tenure will mean smaller EMI but it will also lead to higher interest cost. The reverse is true for loans of shorter tenure. Opt for a short-tenured loan, depending on your repayment capacity and expected future cash flows.
Interest rate:The entire rationale of taking a personal loan is to replace the high interest-cost credit card dues with lower interest-rate personal loans. For example, Platinum Reserve Credit Card from American Express attracts an interest rate of 40.2% p.a. (3.35% per month) while HDFC Bank charges interest rate in the range of 15.75% to 20% p.a. on its personal loans. As a small difference in interest rate can amount to sizeable difference in your EMIs, compare the interest rates charged by various lenders and rates on other available options, such as conversion of the dues into EMIs and loan against FD.
Prepayment charges: Many banks do not allow prepayment of personal loans until the completion of a pre-specified period. Most lenders also have prepayment charges, which usually range from 2% to 5% of the outstanding principal. Opt for a personal loan from a lender that does not charge any prepayment penalty, especially if you expect cash inflow in future. This will allow you to pay off your outstanding balance from any windfall receipts or bonuses without incurring extra charge.
Returns from existing investments:If your existing investments are providing a lower rate of return than the interest rate charged on your personal loan, it will make more sense to redeem/exit those investments and use the proceeds to pay off your credit card debt.However, do not use your emergency funds or investments made for specific financial goals to pay off your credit card debts.
To sum up, it is always a better idea to pay off your financial debt in one go if you can afford it. Opt for a personal loan only if you think that your credit card debt as become too big to be paid within a month or two. Remember, a personal loan is also debt that has to be paid back. It is important for you to change your spending habit that lands you with an unmanageable debt in the first place.
By Naveen Kukreja, Director, PaisaBazaar.com
(Published in Businesstoday.in on May 2, 2016)