Bad Loans vs. Good Loans

In this write-in column I answer your financial questions. Today, I talk about personal loans

Hi Debbie, I keep getting emails from Credit Karma about personal loans that I can use to pay down my credit cards. Should I take out this loan? Don’t feel great taking on more debt and getting another hard inquiry.

Dear Anonymous,

The primary purpose of a personal loan is to help you consolidate your debt. What I mean by this is that a personal loan could allow you to pay off all of your credit cards at once (or even one high-interest credit card), and just be left with one, simpler, lower interest loan (i.e. the personal loan). I say “could”, because paying down debt with debt could be a slippery solution.

I’ve personally heard many stories of people getting themselves in “double trouble” - paying down their credit card debt with the personal loan but continuing to spend on their credit card, leading to 2+ large loans (the original credit card debt + this new personal loan debt). The issue here is that many people take out a personal loan thinking it will solve their credit card problem without addressing the underlying spending behavior that led them to credit card debt in the first place. In addition, sometimes personal loan companies will target existing customers with additional personal loans, which is not necessarily productive in helping people on their debt-free journey. This is a recipe for debt accumulation.

In order to understand whether this solution is right for you, it really depends on the spending habits you have and/or plan to have. If you feel you are a conservative spender and generally pretty responsible with your credit, a personal loan can make a lot of sense in order to avoid the current high interest you are paying (a personal loan interest rate is typically much lower than a credit card). However, if you find that you don’t plan your spending or spend impulsively, a personal loan would probably work best if you immediately pay down your credit card, close the card, and build a budget after receiving the loan. This step will allow to start thinking about how to spending intentionally (i.e. with reason and clear purpose), rather than frivolously, and will hopefully help keep you on track on your debt-free journey. You can use your credit cards again later once you feel your spending is under control and you are in a better position to pay off the entire bill each month, rather than holding a balance.

I hope you now have a better understanding of personal loans and you use them wisely. I think they can be an awesome tool if you take the time to understand your spending

Your financial friend,