Now's the best time to consolidate credit card debt — here's why

Those with high levels of credit card debt may want to start considering personal loans for debt consolidation. According to newly-released Federal Reserve data, the spread between the average credit card and personal loan interest rates is between six and seven points. With numbers like those, using a personal loan to consolidate debt could save you a decent amount of money while also helping to improve your credit score. Read on to learn more.

Is it worth consolidating credit card debt?

The data from the Federal Reserve shows that, in the first three months of 2020, borrowers who had credit card debt were charged an average interest rate of 16.61 percent. Meanwhile, those who used a personalized loan to consolidate debt were only charged interest at a rate of 9.63 percent, which is considerably lower.

At a difference of 6.98 percent, it’s actually the biggest spread between credit card and personal loan interest rates since the Fed began tracking this data in 1998.

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Just keep in mind the exact interest rate you’re given will depend on the specifics of your financial situation.

How consolidating debt with a personal loan may improve your credit score

Beyond helping you to pay down your debts, using a personal loan for debt consolidation may also ultimately help to raise your credit score. It does so in the following ways:

It reduces the amount of debt you owe

First, as stated above, using a personal loan for debt consolidation can help lower the total amount of debt that you owe by reducing the amount that you’ll pay in interest charges. Provided that you don’t then keep using your credit cards to create new debt, you’ll actually owe less money overall.

For example, if you have $5,000 in credit card debt, at a rate of 16.61 percent, you would pay $1,877 worth of interest if you paid off your debt over a period of 48 months. At a rate of 9.63 percent, you would only pay $1,044 in interest over the same period.

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It lowers your credit utilization ratio

The other area that this will impact is your credit usage. Around 30 percent of your credit score is based on what’s known as your utilization ratio, or the amount of credit you’ve used compared to the total amount of credit that you have available. When your existing debt is moved from your credit cards to the personal loan, it will free up your available credit and improve your utilization ratio.

Find out what kind of rates you qualify for with your current credit score.

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It improves your credit mix

The last 10 percent of your credit score is impacted by what’s known as your “credit mix”, or the various types of accounts that are on a borrower’s credit report. By taking out a personal loan, you’re effectively adding a new installment loan to your credit report and improving your credit mix.

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The personal loan terms to consider

However, when you’re shopping around, you’ll want to be sure to compare the following terms to ensure you’re getting the best deal:

• Loan term: The loan term tells you how long it will take to pay back the loan. Typically, you’ll want to pick a loan term that allows you to have a feasible monthly payment. While a longer loan term generally comes with a lower monthly payment, it typically also means paying more in interest charges over time.
• Annual percentage rate (APR): The APR on a loan is a measure that includes both the interest rate and fees. Often, it will give you a truer picture of how much you will pay over the life of the loan than looking at the interest rate alone.
• Collateral: Most personal loans are unsecured, but you may be able to secure a more favorable interest rate if you choose a loan that is secured by collateral.
• Monthly payment: Ultimately, you’ll want to go with a personal loan that has a monthly payment that fits well into your existing budget.