High-interest debt can feel like a trap that you just can’t seem to escape. And without the right tools to help you dig your way out of an ever-deepening hole, you could spend years trying to make some headway.
If you’re hoping to reduce high-interest debt and find your way back to solid financial ground, read on for a look at how a personal loan could provide a much-needed boost, and whether this strategy for managing high-interest debt might be a wise option for you.
Key Points
• High-interest debt is difficult to manage due to compounding interest, minimum payments that don’t reduce principal, and juggling multiple accounts.
• A personal loan can be used to consolidate multiple balances into a single, fixed-rate payment.
• Debt consolidation differs from debt restructuring; consolidation uses a new loan (like a personal loan), while restructuring means negotiating with existing creditors.
• Personal loans offer predictable repayment with fixed interest rates and a set payoff schedule.
• Alternative approaches include the snowball or avalanche payoff method, a balance transfer credit card, or a home equity loan.
Why High-Interest Debt Can Be Difficult to Manage
Managing debt wisely is essential to achieving financial stability. But dealing with high-interest debt from credit cards, payday loans, and bad-credit loans can be especially challenging. Here’s why:
Compounding Interest
People generally expect to pay interest on money they borrow — it’s the cost of doing business. What they don’t always consider, however, is how quickly those interest charges can pile up when they consistently carry forward a balance on their credit cards. (You can use a credit card interest calculator to get an idea of how much you might end up paying over time.)
Unlike simple interest, which is calculated based only on the loan principal, the compound interest paid on a credit card accrues on the principal plus any interest that’s accumulated. And the interest on most credit cards is compounded daily.
If you pay off your credit card balance in full by the due date each month, you may be able to avoid paying interest. But if you let your balance grow, and your interest rate is 20% or more, which isn’t unusual for credit cards these days, those compounded charges can easily become a problem.
Minimum Payments
When the amount of debt you’re in becomes bigger than your budget, it can be easy to fall into the habit of paying only the minimum required each month to keep your credit card accounts current. As long as you pay the minimum due, after all, you won’t have to pay a fee — or worry about the damage a late or missed payment might do to your credit score.
The problem, of course, is that if you continue to take this approach, you’ll make very little progress in paying down your principal balance, and the amount you owe in interest will keep growing. Money that might have gone toward important goals (like saving for a house or investing for retirement) may be swallowed up by payments on your rising credit card balance. And a high credit utilization ratio or high debt-to-income ratio could have a negative effect on your creditworthiness.
Recommended: What Factors Affect Your Credit Score?
Multiple Balances
Trying to pay down multiple accounts, with different interest rates and payment due dates, can make things even harder. If you don’t set up a strategy for handling high-interest debt, the financial consequences and stress will continue to grow along with your balances.
Debt Restructuring vs. Debt Consolidation: What’s the Difference?
Two popular strategies for reducing high-interest debt are debt restructuring and debt consolidation. Though they may sound like the same thing — and they’re often confused — they’re actually completely different approaches to debt management.
Debt Restructuring
With debt restructuring, borrowers work with their creditor or creditors to change the terms and conditions of a loan or credit card account. They might have their interest rate lowered, for example, the balance they still owe reduced, or a loan term extended. Though lenders aren’t obligated to make these types of adjustments, they do sometimes negotiate with borrowers who reach out to let them know they’re trying to get back on track.
Debt Consolidation
Debt consolidation involves taking out a loan or using a balance transfer credit card to reorganize debt payments. The new loan or card may have a lower interest rate or a longer repayment period that makes monthly payments more affordable — and consolidating debts can mean having just one monthly payment that’s easier to manage.
What Is a Personal Loan?
Let’s take a look at how a personal loan works, since it’s often used for debt consolidation. A personal loan is a loan from a bank, credit union, or online lender that’s issued in one lump sum and paid back in regular installments, usually at a fixed interest rate and over a set term. Personal loans are generally considered more flexible than other types of loans, because they’re usually unsecured and the money the borrower receives can be used for just about anything. This is one reason borrowers may turn to a debt restructure personal loan.
Personal loan rates are determined by each individual lender and may vary based on several factors, including the borrower’s income, debt, and credit score. Typically, the better an applicant’s credit score, the more likely they are to be offered a lower interest rate. This can result in significant savings over the life of the loan, which is why it can be helpful to apply for a personal loan before your credit is significantly impacted by high-interest debt.
How Personal Loans Can Change the Structure of High-Interest Debt
For some borrowers, using a personal loan for debt consolidation can be a practical way to reduce high-interest debt and simplify a repayment process that feels like it’s spiraling out of control. Here are some things a personal loan can offer:
Fixed Interest vs. Revolving Debt
When you take out a personal loan, it usually comes with a fixed interest rate, which means you can expect to pay the same rate for the length of your loan. With a credit card, or other forms of revolving debt, the interest rate is often variable: the cost of borrowing can fluctuate based on changes in the market and also your personal behavior. If you miss payments, pay late, or your credit score drops, your credit card issuer may decide to raise your rate.
A Defined Payoff Schedule
Along with a predictable interest rate, personal loans are repaid in fixed monthly installments, which can make budgeting and planning much easier for borrowers. Reorganize debt payments into a predictable payment and you may find it easier to keep track of your finances.
Combining Multiple Balances into One Payment
If you’ve been juggling multiple credit card payments and other high-interest debts, a personal loan can help you get back on track by combining those obligations into one manageable monthly payment. And if you can remain disciplined and avoid carrying a balance on your credit cards going forward, you’ll know exactly when you’ll be done with that debt.
Recommended: Guide to Personal Loans for Beginners
Situations Where Debt Consolidation May Help
Debt consolidation isn’t the answer for everyone, but it can be a useful tool for borrowers who want a clear and stable pathway for climbing out of debt. This strategy may be particularly helpful for those who are struggling with:
Credit Card Balances
If you’re carrying forward credit card balances from month to month, you could be paying hundreds or even thousands of dollars in interest each year. If you consolidate those debts with a personal loan, you may be able to lower your interest rate (personal loan rates are generally lower than credit card interest rates) and reduce the amount you’re paying every month.
Multiple Creditors
The more creditors you’re dealing with when you’re deep in debt, the harder it may be to negotiate for new and improved terms — or even to monitor what you owe. Consolidating can streamline your bill-paying process and reduce the effort that goes into monitoring your debt.
High-Interest Debt Across Accounts
Borrowers who’ve fallen behind on their credit card payments often are contending with other high-interest debts as well. Combining all those nagging bills into one personal loan payment and making sure that payment is always received on time could have a positive impact on your credit score.
Risks and Tradeoffs
Using a personal loan to manage high-interest debt is a strategy that can benefit many borrowers, but there are situations when it might not make sense, for example.
• If your credit is shaky, you may not qualify for a loan with a rate that’s low enough to make consolidating worthwhile. Borrowers with good to excellent credit generally qualify for the most competitive interest rates.
• Without self-discipline, you could fall into an even deeper debt trap. If you think you’ll be tempted to start using your credit cards again once you pay down your balances, you may want to look for a different high-interest debt strategy.
• For consolidating to be cost-effective, the savings should exceed your loan’s costs. When comparing various lenders, it’s important to note the fees they do or don’t charge, including loan origination fees, late payment fees, and prepayment penalties.
• The length of your personal loan term could also impact your costs. While a longer loan term usually means you’ll have smaller monthly payments (which can be appealing), it’s also likely you’ll end up paying more in interest over the life of the loan. If you can afford the payments, choosing a shorter loan term is generally more cost-efficient: You’ll pay interest for a shorter period of time and you may be able to score a lower interest rate.
Alternatives to Consider
A personal loan is a popular choice for borrowers who are trying to tunnel their way out of high-interest debt — but there are other options. Depending on your individual circumstances, you may also want to look at:
DIY-ing a Debt Payoff Plan
If you think you can tackle your debt on your own, but you need a strategy to get started, either the “snowball” or “avalanche” approach might help.
• Debt snowball method: “One go-to way to pay off debt is the snowball method. You pay off your smallest balance first, while keeping up with minimum payments on other debt. The benefit is seeing some of your debt paid off sooner,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi. Any extra money you have will go toward paying down that lowest balance. When you’ve managed to pay off that account, you can celebrate the win and then move on to the second-lowest debt — and so on.
• Debt avalanche method: Another approach to debt also involves making all your minimum payments, but then focusing on paying down your accounts based on which has the highest interest rate. Any extra cash you have would be directed to that payment. When you’ve eliminated your highest-interest debt, you’ll tackle the account with the next-highest interest rate, and so on. As you work your way through all your outstanding accounts, you’ll save money by paying less and less toward interest charges.
Using a Balance Transfer Card
Borrowers who have strong enough credit to qualify for a balance transfer credit card with a reduced interest rate may want to consider using this option to combine their existing credit card balances into one account.
It’s important to remember, though, that the introductory rates offered on balance transfer cards are only temporary, and usually last for just 12 to 21 months. After that, the card’s standard interest rate will kick in, and will apply to whatever balance remains. Borrowers also may have to pay a balance transfer fee — typically 3% to 5% of the total amount transferred.
Borrowing Based On Your Home Equity
If you own your home, and you’ve managed to build up some equity over time, a home equity loan is another potential option for combining and paying down your high-interest debt. Because it’s a secured loan (using your home as collateral), you may be offered a lower interest rate than you can get with a personal loan, which could save on costs. But you can expect more paperwork when applying for a home equity loan, and getting an approval can take longer than with a personal loan. The upfront fees are also likely to be higher. Most important: If you can’t keep up with payments on a home equity loan, you risk foreclosure.
Working with a Debt Relief or Debt Settlement Company
As mentioned above, borrowers can attempt to restructure their debt on their own by working with their lenders to lower the amount they owe or to change their loan terms. There are also companies that will do this work for you — for a fee. This strategy has some risks, however. The cost of hiring a debt relief or debt settlement company can be high — typically ranging from 15% to 25% of the debt enrolled. And there’s no guarantee your creditors will agree to adjust your debt. (Some lenders won’t even engage with debt relief firms.)
The Takeaway
Falling into a high-interest debt trap is pretty easy. Finding a way out can be far more challenging — and may require getting some help. As you consider the pros and cons of one high-interest debt strategy vs. another, think about your individual situation and how your choices will affect your future goals. Using a personal loan for debt consolidation is a popular and proven financial tool, especially for borrowers who can qualify for a competitive interest rate.
Credit cards have an average APR of 20%–25%, and your balance can sit for years with almost no principal reduction. Personal loan interest rates average 12%, with a guaranteed payoff date in 2 to 7 years. If you’re carrying a balance of $5,000 or more on a high-interest credit card, consider a SoFi Personal Loan instead. See your rate in minutes.
FAQ
Is debt restructuring different from consolidation?
With debt restructuring, borrowers negotiate with individual creditors to adjust the terms and conditions of their credit cards and/or loans. Debt consolidation involves taking out a brand new loan to combine and pay off existing debts.
Can debt consolidation reduce monthly payments?
A new loan may have a lower interest rate or a longer repayment period that can make monthly payments more affordable — and having just one monthly debt payment can be easier to manage.
Can consolidating debt improve credit?
Consolidating debt could have a negative impact on your credit score if you close all the credit accounts you consolidate, because it would likely reduce your credit utilization ratio, which is one aspect of your credit score. But if you can keep these accounts open and avoid charging on them, and if you make your debt payments on time, you may positively affect your overall credit score. (Applying for a loan could cause a small dip in your score due to a hard credit inquiry, but this is temporary.)
When is debt consolidation not recommended?
If you can’t qualify for a better interest rate or more affordable payments than you already have, it may not be worth consolidating. (Although making just one payment every month could be beneficial if you’re having trouble tracking and managing multiple bills, creditors, and interest rates.)
Photo credit: iStock/Yaroslav Olieinikov
SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®
SOPL-Q126-098