As the mounting financial pressure continues to burden Americans, creative solutions are being sought to dig out of the rising debt. The collective credit card debt in the country has hit a staggering $1 trillion, with delinquency rates on the rise and the monthly balance climbing to $5,947 in the second quarter, up from $5,270 a year ago, as per a recent TransUnion report. Amid the pandemic-era excess savings running dry and the looming resumption of federal student-loan payments in October, one solution gaining traction is the use of personal loans to consolidate credit-card debt.

However, the effectiveness of this strategy largely depends on an individual’s credit score, a crucial factor for securing a loan with an interest rate lower than that of a credit card. According to Federal Reserve statistics, the average interest rate for a two-year personal loan is around half the average 22% APR for a credit card carrying a balance and accruing interest. Interestingly, credit card debt consolidators have managed to slash nearly half of their balances on average and improve their credit score by 18 points between April 2021 and September 2022, as revealed by recent research from TransUnion. But the success of this approach requires careful planning and disciplined spending habits to ensure the credit card debt does not return.

Tackling Rising Debts: Is Consolidation the Key?

In a climate of increasing financial pressures, Americans are grappling with a collective credit card debt of $1 trillion, with delinquency rates on the rise. Amid the pandemic, excess savings are dwindling and federal student-loan payments are set to resume in October. One potential solution to these mounting pressures is the consolidation of credit card debt through personal loans. However, this approach requires careful planning and discipline to avoid falling back into old spending habits.

The Impact of Credit Score

A significant factor in debt consolidation is the borrower’s credit score. A good credit score can secure a personal loan with an interest rate lower than that of a credit card. This can be particularly beneficial in the current climate where interest rates are rising. Credit card debt consolidators were able to reduce their balances by almost half and improve their credit scores by 18 points between April 2021 and September 2022, according to a recent report by TransUnion. However, the report also highlighted that many consumers returned to their previous debt levels within 18 months.

Benefits and Risks of Consolidation

Consolidating credit card debt into a personal loan can help manage debt while freeing up monthly budget funds. However, Margaret Poe, head of consumer credit education at TransUnion, emphasises the necessity of pairing consolidation with changes in spending habits to prevent the return of credit card debt. Other studies, such as a recent LendingTree study, also support the benefits of consolidation, showing a significant increase in credit scores of people who used personal loans to pay off their card balances.

Personal Loan Rates and Economic Trends

As of early August, the average interest rate for three-year loans was 15.04%, an increase from 10.65% a year ago, according to Credible. Five-year loans averaged 18.84%, up from around 15% a year ago. These high rates have discouraged many consumers, with the number of personal loans originated in the first quarter of 2022 dropping significantly.

Lenders have also been cautious due to rising inflation and a turbulent economy, leading to a pullback on personal-loan offers. The banking crisis that began in March with Silicon Valley Bank’s failure has further tightened lending standards, leading to an increase in rejections for mortgages, car loans, and credit cards.

Weighing Up Debt Consolidation

Before considering a personal loan, Matt Schulz, chief credit analyst at LendingTree, advises exploring the option of a 0% balance transfer card. However, this option also has its risks, as the introductory 0% rates are time-limited and can lead to higher penalties if the full balance is not paid once the 0% rate expires.

Consolidating credit card debt into a personal loan can increase a consumer’s spending power, potentially leading to an improved credit score or a return to excessive spending. Therefore, careful planning and discipline are essential when considering debt consolidation to ensure that it does not result in a more challenging financial situation.

Key Takeaways

Rising debts and financial pressures require strategic solutions, and debt consolidation through personal loans can be an effective approach. However, it is not a one-size-fits-all solution and requires careful consideration of personal circumstances, credit scores, and potential risks. As economic trends continue to evolve, consumers must remain vigilant and disciplined in managing their finances.