Interest Rates for 5-Year Personal Loans Have Fallen. Here's What That Means for You

There's no such thing as a one-size-fits-all loan.

Let's be honest. Although personal loan interest rates have fallen, they're nothing to brag about. As of this writing, rates on a 5-year fixed-rate loan averages 17%, down 17.66% from last week. Still, if you're carrying high-interest debt and want to get out from under it, you might be able to make an interest rate of 17% work for you. Here's how.

Work the numbers

Let's say you have three credit cards, each with a $10,000 balance. Each card carries an interest rate of 21%. You're making a monthly payment of $825, but are being eaten alive by interest.

If you remain on the same path and never lower your payment (even as the balance drops), it will take you just shy of five years to pay the cards off in full, and you'll pay a staggering $18,100 in interest.

Five-year fixed-rate loan

Now, let's say you take out a 5-year personal loan with an interest rate of 17% and use those funds to pay off your credit cards. Your monthly payment will run you $745 and you'll pay a total of $14,700 in interest. While the savings doesn't represent a small fortune, it does leave you with an extra $3,400 to sock away in an emergency savings account or pay down other debt.

Taking out a fixed-term loan to pay off existing high-interest debt also offers these benefits:

• You have the option of hiding those cards away in the freezer and not using them. Becoming a cash-only household is a great way to set your feet on solid financial ground.
• You know precisely when the debt will be paid off. Better yet, if you receive a bonus, tax refund, or other "found" money, you can put it toward the loan, moving your payoff date up.
• It will be good for your credit score. A whopping 30% of your total FICO® credit score is based on what's called a "debt-to-credit utilization ratio." In short, this ratio measures how you use revolving credit (like credit cards). The less you owe on the cards, the lower your credit utilization ratio. And the lower your ratio, the higher your credit score.
• It may give your credit score a boost in one more way. Another factor that goes into determining your credit score is called "credit mix." Lenders like to see that you can handle different types of credit. Adding a personal loan to your mix can raise your score by as much as 10%.

Three-year fixed-rate loan

One other way to shed yourself of high-interest debt is to consider taking out a shorter-term personal loan to pay existing debt off in full. Rates on 3-year fixed-rate loans today average 12.95%. That's up a bit from last week, but still lower than the rate attached to a 5-year loan.

Let's take a look at how a 3-year loan might help. Using the same scenario, imagine you have $30,000 in credit card debt to pay off. You consolidate that debt by taking out a 3-year loan at 12.95% interest.

Your monthly payment jumps to $1,010, but you're out of debt in 36 months and pay a total of $6,363 in interest. Compare that number to how much you'll pay in interest if you continue to pay the credit cards off without consolidating, and you'll find that you save a whopping $11,700 in interest.

Unless you're carrying high-interest debt, today's personal loan rates are not particularly attractive. But, if you do have this kind of debt hanging around your neck, a personal loan may make sense.

The caveat

The higher your credit score, the lower the interest rate you'll be offered. While there are lenders that work with people with bad credit, you must carefully consider whether consolidating your current debt will save money.

The best personal loan lenders charge no needless fees. For example, there are no administration fees and no penalties for paying the loan off early.

Before you make a move, do your homework. Shop around with different personal loan lenders to learn which offers the best deal. Most lenders run a "soft" credit check before making you an offer. A soft pull will not impact your credit score. It's only when you accept an offer that the lender runs a hard credit check to make sure everything is in order. Though your score will dip a bit following the hard credit check, it will rebound quickly with regular payments.

While an interest rate of nearly 13% might be all wrong for one consumer, only you can determine whether trading high-interest debt for a lower interest rate will leave you with more money in the bank.