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How Personal Loans Impact Debt: What You Should Know

elinorr
Elinor Rozenvasser Updated: August 30, 2023 • 4 min read

Key Points:

  • While personal loans are often considered a solution for credit card debt, recent studies highlight their limitations. Borrowers saw temporary relief, but balances rebounded within months, questioning the long-term effectiveness.

  • Amid record credit card balances and escalating interest rates, addressing the growing debt burden is crucial. Identifying effective strategies is vital to prevent further financial challenges.

  • Personal loans offer lower interest rates for debt consolidation. Achieving success requires changing spending habits, maintaining financial discipline, and thorough research to find the right lender and terms.

Tackling credit card debt can be tough, leading many to consider personal loans as a solution. However, recent studies show that personal loans might not always be the magic fix. Let's delve into the details and find out why personal loans might have limitations when it comes to managing credit card debt, and how to overcome them when choosing the right loan. 

The Reality of Personal Loans

While personal loans are often seen as a remedy to consolidate credit card debt and lower interest rates, studies reveal that the results might not be as long-lasting as hoped. Research conducted between April 2021 and September 2022 by TransUnion found that borrowers who used personal loans to consolidate credit card debt saw their balances drop by an average of 57%. However, for many, these reduced balances started creeping back up within just 18 months.

LendingTree, a respected financial research firm, also discovered similar trends. Their data showed that borrowers were often accumulating credit card debt again within three months after using personal loans for consolidation. This suggests that while personal loans can offer temporary relief, they might not be the ultimate solution to debt management.

The Challenge of Increasing Debt

These findings highlight a growing concern in the United States – the rising debt burden faced by individuals. Credit card balances are hitting record highs, with interest rates exceeding 20%, and missed payments are on the rise. It's vital to address this issue before it escalates further.

Credit card balances are hitting record highs, with interest rates exceeding 20%

One of the attractions of personal loans for debt consolidation is the lower interest rates they offer compared to credit cards. While credit cards can come with rates surpassing 20%, the average interest rate for a personal loan, especially for those with good credit, is typically under 10%. This makes personal loans an appealing option for individuals aiming to reduce interest costs and gain better control over their debt.

A shift in spending habits is key. Personal loans can provide temporary relief, but their effectiveness over the long term hinges on changes in spending behavior. TransUnion's study revealed that borrowers initially decreased their credit utilization (the percentage of available credit they used) from 59% to an average of 14% after consolidating with a personal loan. However, discipline tended to wane, and 18 months later, many borrowers were using 42% of their available credit, regardless of their risk level.

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For those who used personal loans to pay off $1,000 to $4,999 in credit card debt, the average balance initially dropped from $9,541 to $7,004 within two months of consolidation. Unfortunately, this balance rebounded to $8,476 by the fifth month. This indicates that while personal loans can offer initial relief, maintaining financial discipline remains crucial for sustainable debt management.

Inflation and Other External Factors at Play

Factors like inflation and reduced pandemic-related stimulus support have pushed more individuals to rely on credit cards. As interest rates rise, managing credit card debt becomes even more challenging. Many view credit cards as a safety net during financial hardships, but their high interest rates can quickly transform them into financial burdens.

Unlocking Financial Potential: Thriving with Personal Loans

Managing credit card debt might be daunting, but a solution gaining traction is personal loans. With careful planning and the right strategy, personal loans can be a valuable tool to regain control over finances. Let's explore how personal loans can work for you and how to optimize their benefits.

Personal loans provide a pathway to alleviate the weight of credit card debt. Recent research highlights that borrowers who consolidated credit card debt using personal loans experienced significant reductions, with balances decreasing by an average of 57%. This initial success underscores the potential of personal loans to offer financial stability.

To harness the full benefits of personal loans, selecting the right lender and terms is vital. Here's where your journey towards financial empowerment begins:

Evaluate Lenders: Not all lenders are equal. Research reputable lenders offering personal loans tailored to your needs. Seek those with competitive interest rates, flexible terms, and a history of customer satisfaction.

Compare Interest Rates: Interest rates can vary widely among lenders. Take time to compare rates and identify a loan that aligns with your budget. Lower interest rates translate to less interest paid over time.

Understand Loan Terms: Thoroughly review and comprehend the loan's terms and conditions. Ensure you're comfortable with the repayment schedule, associated fees, and potential penalties.

Personal Loans: Harnessing the Advantages

Personal loans are emerging as a favored approach for debt management due to several advantages:

  • Lower Interest Rates: Personal loans generally offer lower interest rates compared to credit cards, which often carry rates exceeding 20%. This can result in substantial long-term savings.

  • Streamlined Consolidation: By consolidating multiple credit card balances into a single personal loan payment, your financial management becomes simpler. Monitoring one monthly payment is more straightforward.

  • Predictable Repayment Schedule: Personal loans typically come with fixed monthly payments, facilitating budgeting and future financial planning.

  • Clear Repayment Timeline: Personal loans are associated with a predetermined repayment period. This provides a clear timeline and goal for achieving a debt-free status.

Navigating Towards Financial Freedom

While personal loans can be a powerful tool, achieving success necessitates prudent planning and responsible decision-making:

  1. Strategic Borrowing: Borrow only what you truly require. Consider your financial situation and create a pragmatic repayment plan.

  2. Effective Budgeting: Develop a comprehensive budget that prioritizes debt repayment. Allocate funds towards your personal loan payment while covering essential expenses.

  3. Sustaining Financial Discipline: Throughout the personal loan repayment journey, maintain financial discipline. Avoid frivolous spending and remain focused on your long-term financial aspirations.

The Bottom Line

Anyone is capable of seizing control of their financial trajectory by delving into the potential offered by personal loans. By assessing lenders, comparing rates, and comprehending terms, you can secure a loan that aligns with your objectives and propels you toward financial independence.

Imagine a life characterized by reduced stress, manageable debt, and a well-defined financial roadmap. Personal loans could be the key that unlocks this transformative vision. 

Elinor Rozenvasser is a content writer and editor with a knack for finance. She holds a Bachelor's in Communications and Business from Reichman University, and has been swimming alongside finance specialists for over a decade. She's not your typical financial writer, though. She's more likely to use witty puns and sarcasm than jargon and technical terms. But don't let that fool you. She's still a whiz when it comes to explaining complex financial concepts in a way that anyone can understand. If there's any writer who can make finance fun and engaging, Elinor is your girl. She's sure to leave you laughing (and learning) long after you've finished reading her work.