Many credit cardholders mistakenly consider their credit cards as an extension of their income, leading them to spend more than what they can afford. As they continue to falter on their bill repayments, their outstanding balance grows at a rapid pace because of higher rate of interest (as high as 47 per cent) and late payment fee. One of the most popular ways to pull out of a burgeoning credit card debt trap is to avail a personal loan.
How personal loan helps in getting of credit card debt trap
Low interest rates: Interest rates of credit cards are significantly higher than those of personal loans. While the interest rate of personal loans can range anywhere between 10.65 per cent - 24 per cent, interest rate on credit card outstanding can go upto as high as 47 per cent. The savings made on lower interest cost can be used to make faster repayment of your accumulated debt.
Easier to manage repayments: While credit cards also allow conversion of outstanding balances into EMIs, those with outstanding dues on multiple cards would mean multiple EMI schedules and due dates. Instead, availing a personal loan to pay off multiple credit card debt will help consolidate your debt for a single interest rate, EMI, date of payment and loan tenure. Based on your loan repayment capacity, you can choose a personal loan tenure ranging anywhere from 1 year to 5 years.
Things to keep in mind while opting for personal loan to repay your credit card dues
Credit score: Being unsecured loans, lenders charge higher interest or reject the personal loan applications of those with low credit score. As credit cardholders with accumulated debt may already have low credit score due to missed repayments, their possibility of availing personal loans at attractive rates or even loan approval itself would stand reduced.
Also, making direct loan enquiries with multiple lenders might do more harm than good as lenders report such enquiries to credit bureaus who, in turn, can reduce the credit score for each enquiry. This will further reduce your credit score, and loan eligibility too.
What to do: Instead of directly applying with the lenders, visit online lending marketplaces to get the best personal loan offers available on your credit score without reducing it.
Loan Tenure: The tenure of your personal loan will play a major role in the calculation of your EMI and overall interest cost. Longer loan tenure will lead to smaller EMIs but higher interest cost whereas the reverse would be true for loans with shorter tenures.
What to do: Opt for loan tenure based on your repayment capacity and expected future cash flows. Failing to keep up with an aggressive repayment schedule would increase your borrowing costs through late payment penalties etc., and push you deeper into the debt trap.
Interest rate of other alternative loan options: As saving on interest payments is the main objective of availing a personal loan to repay credit card dues, interest rates charged on other alternative loan options like loan against property, top-up home loans, gold loan, loan against securities etc., should not be ignored. As these alternative loan options are mostly secured in nature, their interest rates could well be lower than those available to you on personal loans. Some may also offer longer loan tenures, thereby reducing your EMI burden.
What to do: Compare the interest rates of alternative loan options charged by various lenders though online financial marketplace to avoid any implication on your credit scores. .
Prepayment charges: Prepayment of personal loans in part or entirety helps reduce your interest cost. However, most lenders penalize prepayment or foreclosure of personal loans by charging 2 per cent to 5 per cent of the outstanding loan principal as pre-payment and foreclosure charges.
What to do: Prefer a personal loan without any prepayment penalty if you are planning to prepay it in future.
Returns from existing investments: Most fixed-income and debt investment options like FDs, debt funds, company deposits, non-convertible bonds etc., offer lower rate of returns than the interest rates charged on personal loans. However, equity investments can generate higher rate of returns than most personal loan interest rates during booming market conditions.
What to do: Redeem your debt or fixed income investments for paying off credit card dues if those investments are not linked to your short term financial goals. Do not use your equity investments earmarked for unavoidable financial goals as that might force you to opt for costly loans in future. Also desist from using your emergency funds as unforeseen financial emergencies might force you to avail costlier loans.
— By Naveen Kukreja – CEO & Co-founder, Paisabazaar.com...