Credit Cards today are an integral part of our financial lives. They allow quick access to emergency credit, provide an interest-free period of 20–55 days and also help us improve our credit score steadily. In fact, through various offers attached to a credit card, like cashback, reward points, air miles etc. they may enable us to reduce transaction cost over the long run.
The problem starts when we start using credit cards to finance our lifestyle needs in an indisciplined manner. You start spending more than what you can afford and fail to repay your total dues every month. With your outstanding balance attracting interest costs of 22–48% p.a., it reaches a point where even the payment of ‘minimum amount due’ becomes difficult. You find yourself in what is known as the classic example of a debt trap where the only solution is to avail a lower-cost loan option to repay your burgeoning credit card debt. Of the various options available to come out of such card debt traps, personal loan has emerged as one of the most convenient and relatively cheaper options.
Why personal loans for paying off your credit card balance?
Low interest rates: Personal loans in India charge significantly lower interest rates than credit cards. While your credit card balance will attract an interest rate of 22–48% p.a., personal loan interest rates will vary between 11–24%. A lower interest rate not only reduces your overall payable interest cost, it also helps in faster debt repayment.
Consolidate several debts under one head: Managing outstanding balances of two or more credit cards can be a difficult task, especially for those who fail to keep track of multiple due dates and outstanding balances. Taking a personal loan will allow you to pay off multiple credit card balances at one go and replace them under a single debt head. This will eliminate the hassle for remembering multiple due dates and making repayments of multiple dues.
Quick disbursal: Personal loans have one of the fastest disbursal procedures among all loan options. While some banks claim to disburse personal loans within 2 days, most personal loans are disbursed within a week if documentation and eligibility conditions are easily met.
Comfortable repayment options: Unlike credit cards where the entire outstanding dues have to be paid within the due date to avoid interest cost and penalties, personal loans allow you to spread your repayment in small but equal tranches for 1–5 years. This tranches are known as EMIs and can be fixed on the basis of your monthly cash flows. You can easily find your EMI amount by using various personal loan EMI calculators available on the web.
Things to do before availing a personal loan for credit card debt repayment
Enquire about conversion of credit card dues to EMIs: Most credit card issuers allow their cardholders to convert their card dues into EMIs. The minimum threshold amount required for such conversion can be as low as Rs 3,000. Before availing a personal loan, make sure to contact your credit card issuer about the rate of interest, tenures and processing charges applicable in EMI conversion. Opt for such conversion if the rates and other features offered are more attractive than those offered by personal loan products available to you.
Take out your free credit report: Lenders use credit score to evaluate your personal loan application. Borrowers with higher credit score are more likely to avail personal loans at better terms. Thus, first take out your free credit report from an online marketplace like paisabazaar.com to know your credit score and look for errors, if any. In case, there are any errors, ask your lender(s) and the credit bureau to make the required corrections. This will help increase your credit score. Additionally, availing free credit report from online lending marketplaces will also enable them to forward competitive loan offers available on your credit score.
Compare interest rate offered by various lenders: The entire rationale of taking a personal loan for paying off your credit card debt is to reduce your interest cost. However, the interest rate of personal loans can vary widely across banks. Some banks charge personal loan interest rates starting from 15.50% p.a., while the interest rates charged by others start from around 11% p.a. Even as a small difference in your interest rate can lead to a sizeable difference in your EMIs and overall interest cost, make sure to compare the interest rates offered by various lenders.
Opt for a tenure according to your repayment capacity: Loan tenure plays a major role in determining your EMI amount. Although, lenders offer personal loan tenures from 1 to 5 years, factors like your monthly income and other existing EMIs are also factored in while fixing your loan tenure. Remember that a longer tenure leads to smaller EMIs but it also results in higher interest cost. The opposite is true for shorter-tenured loans. Opt for a short-tenured loan only when you are confident of your repayment capacity and future cash flows. Else, you may once again land in a debt trap with a badly thrashed credit score.
Compare conditions and charges related to prepayment: Most lenders place restrictions on prepayment of personal loans. While most banks do not allow prepayments before the completion of a pre-specified period, others like ICICI Bank do not allow part pre-payment at all. While most lenders charge prepayment charges of 2% to 5% of the amount prepaid or outstanding principal, some like Axis Bank do not penalise prepayments. Prefer a lender that does not charge any prepayment penalty as it will allow you to use future windfall receipts or bonuses for prepayments without incurring extra charge.
List the rate of returns generated by your existing investments: The rates of returns generated by fixed income investments are lower than interest charged on credit card dues. For example, while some small finance banks offer the highest interest rate of 9% p.a. among all bank fixed deposits, credit card dues attract interest rates starting from around 22%. Thus, redeeming such low-yield investments for paying your credit card debt will make more sense than continuing with them. However, never use your emergency funds or investments made for long term financial goals to pay off your credit card dues. Also avoid redeeming your equity investments for repaying card dues as equities are highly volatile and selling them off can lead to missed opportunities of earning higher returns.
Evaluate outstanding balance transfer options to other card issuers: Credit cardholders also have the option to transfer their credit card balance to another card issuer. Card issuers may also offer you a limited interest-free or low-interest rate period on such balance transfers. However, their usual higher rate of interest would be applicable after the completion of such offer period. As such period can range anywhere between 3 months to 36 months, opt for such transfers only when you are confident of repaying the outstanding within the offer period. Also ensure that their interest rates are lower than those of personal loans.
Compare alternative secured loan options: Being unsecured loans, personal loan interest rates could be significantly higher than secured loan options like loan against securities, loan against FD, or top-up loans. Loan against securities or FDs allow you to secure additional funds without actually selling or redeeming them. Meanwhile, existing home loan borrowers should always consider top-up loans before other credit options as they charge lower interest rates and offer higher tenures than personal loans.
Visit online lending marketplaces to compare loan features: Applying directly with multiple lenders for loans within a short span can adversely affect your credit score and loan approval. On each application, lenders will request your credit report from the credit bureaus to evaluate your creditworthiness. These enquiries are then recorded in the enquiry section of your credit report. As lenders consider too many loan applications within a short span as a sign of credit hungriness, credit bureaus accordingly reduce your credit score.
Instead, avail the services of online lending marketplaces for comparing loan features. Although, the online lending marketplaces too will request your credit report, their requests are considered as soft enquires and are not factored for calculating your credit score. Thus, your credit score remains intact even when you get to compare the interest rates and other features offered by various lenders.
Never hide your existing debts during loan applications: Borrowers often try to understate their existing debt in the hope of getting a higher loan amount. However, they fail to realise that lenders will anyway fetch their credit report before approving their loan application. The credit reports list all your existing and past debt obligations and repayments, including your existing credit card dues. Such deliberate understatement can also lead to the rejection of your loan application.While one should never use his credit card in a manner that he cannot repay the entire bill amount by the due date, but in case, someone gets stuck in a situation with a burgeoning credit card bill, which is beyond his repayment capacity, a personal loan can prove to be a cheaper option to come out of the debt trap.
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