How Taking Out a Personal Loan to Pay Off Credit Cards Could Backfire

If you have credit card debt, you probably already know you're paying a pretty high interest rate. The average rate on credit cards was 21.47% as of November 2023. By comparison, the average interest rate on a personal loan during the same time period was 12.35%.

Since the interest rate is so much lower on the typical personal loan, some people might consider taking out a debt consolidation loan and using it to pay off what they owe on their cards. Doing this can reduce the interest rate, and can make it much cheaper and easier to pay off the balance due.

There is, however, one big catch. In some situations, this approach can backfire big time and leave you in much more debt than you started with. Here's how that can happen.

You could end up deeply in debt if you make this mistake

If you use a personal loan to pay off credit cards, there's a big risk you're taking on. The risk comes from the fact that you are freeing up the credit on those cards.

Let's say, for example, that you had two cards with $5,000 limits each and you owed about $5,000 on one and $4,500 on the other -- and you took out a $10,000 personal loan to pay off the balance.

While you previously only had around $500 in available credit on your cards, you now have $9,500 available. And this means you have the option to start charging purchases again.

Unfortunately, you may be tempted to do that. Moving the credit card balances over to the personal loan can make you feel as if you've made progress on debt payoff, even though you've only shifted the balance and reduced the costs of repayment. You haven't actually taken any meaningful steps to tackle the debt for good. You may also feel as if you might as well start using the cards again, now that you don't "owe" on them.

If you do start charging purchases on your cards again that you can't pay off in full, though, you could quickly end up with a big balance again. But your loan will still be there. If you let things get out of control and max out the $5,000 card again, you'd owe somewhere around $14,500 instead of the $9,500 you'd have owed if you just left the cards alone instead of refinancing them with the personal loan.

How to make sure you don't charge up your cards again

If you want to avoid this mistake, you should absolutely not even consider taking a personal loan to pay off credit card debt until you are 100% confident you won't find yourself carrying a balance on the cards again.

To do this, try living on a budget first that involves spending less than you earn. Be consistent in doing this for a few months to see if you can stick to it. And save up at least a small emergency fund of around $500 to $1,000, so you won't be tempted to reach for your cards to cover unexpected expenses.

By taking steps to ensure that you won't behave irresponsibly with your cards after transferring the balance of those cards to a personal loan, you can avoid making a very costly mistake that it could be difficult to recover from.