The average credit card interest rate is near historic highs, sending consumers with balances into a whirlwind of high-interest debt that can leave them wishing for a better solution.
Credit card rates peaked at 21.76 percent in August 2024 and have since dropped gradually to 20.79 percent, according to the latest data from the Federal Reserve. On the other hand, the average rate for a two-year personal loan is 11.65 percent, Fed data shows.
The considerable difference in rates between credit cards and personal loans – and other factors – highlights the financial relief that consolidation provides.
“Consumers generally use consolidation loans because of the lower interest rates and fixed repayments which this route offers,” said Nick Cherry, Division CEO of debt recovery firm Phillips & Cohen Associates, in an email to The Independent. “Simplicity and budget certainty are key factors.”
Consolidation basics
Credit card consolidation is combining multiple credit-card balances – and payments – into one loan and one payment, the Consumer Financial Protection Bureau notes.
“Consolidation means that your various debts, whether they are credit card bills or loan payments, are rolled into a new loan with one monthly payment,” the bureau says. “If you have multiple credit card accounts or loans, consolidation may be a way to simplify or lower payments.”
Borrowing basics
Shifting credit card debt into a personal loan offers two distinct advantages. Firstly, there’s a good chance that your interest rate will be lower, as the average rate for a personal loan is nearly half as much as a credit card’s average rate.
Second, personal loans have a fixed payment schedule and a defined payoff date. Credit cards don’t; they charge a minimum payment that’s based on your balance, not a fixed payoff date in the future. That means a cardholder could make their minimum payment for years and see only modest progress in paying down their balance.
Additionally, credit cards allow spending as long as the cardholder hasn’t hit their credit limit. So, someone could rack up a $5,000 balance, pay the balance down to $2,500, then make more purchases that drive the balance back up to $5,000.
Personal loans work the opposite way. Generally speaking, lenders issue loan funds once, shortly after loan approval. Borrowers typically can’t ask for more loan funds in the middle of repayment.
The advantages a personal loan offers make them a little harder to qualify for than credit cards, said Naeem Siddiqi, senior risk advisor at data and AI provider SAS.
“Personal loans tend to be harder to get compared to credit cards,” Siddiqi told The Independent in an email. “These loans are priced lower, carry a lower risk (from the lender’s perspective), and usually offer higher amounts compared to credit cards.”
Simple steps
To consolidate credit card debt, borrowers should get prequalified for personal loans from at least three different lenders.
Once they find a loan with the right mix of interest rate, repayment term, and monthly payment, they can move forward with a loan application.
If approved, lenders typically allow the borrower to use the loan funds to pay off credit cards, or the lender will do it on behalf of the borrower.
“Consumers need to remember that consolidation doesn’t eliminate debt; it just moves debt from one lender to another,” said Brit Simon, chief experience officer at debt relief firm National Debt Relief.
“A personal loan can make sense for someone who wants more structure around paying off high-interest balances,” Simon said in an email to The Independent. “The new structure should be reviewed, and consumers should ensure it improves their overall financial situation, and they can make the committed payments in the timeline outlined.”
Mind-blowing savings
The greatest advantage of credit card debt consolidation is the money a borrower saves on interest payments.
Imagine someone has $15,000 in debt across three credit cards – $5,000 on each card. The average annual percentage rate across all three cards is 22 percent. Each minimum payment includes interest plus 1 percent of the balance, leaving the borrower with around $420 in monthly payments to start (payment amounts decrease as the balances decrease).
In that scenario, it would take the cardholder more than 23 years to pay off the debt and cost nearly $10,600 in interest payments.
Instead of grinding out 23 years of credit payments, say the cardholder opts to consolidate the three balances into one personal loan. They get a five-year, $15,000 personal loan at 15 percent.
The loan would take five years to pay off, cost around $6,400 in interest, and have a fixed monthly payment of around $357.
Benefits beyond interest
In addition to saving money on interest payments, personal loans offer another distinct advantage for a borrower’s financial health – a boost in credit scores.
The typical credit score is heavily influenced by the percentage of a borrower’s credit-card limit they’re using. The general rule of thumb is that using less than 30 percent of available credit-card limits brings the most benefit to a credit score, according to credit bureau Experian.
When a borrower pays off their credit cards with a personal loan, all balances drop to zero. That drastic change in credit utilization could potentially result in a double-digit increase in the borrower’s credit score.
Brain boost
There’s a psychological benefit that comes with attacking and paying down debt with a consolidation loan, too.
Debt carries a psychological load that is taxing for borrowers, a trio of researchers found in a 2019 study published in the Proceedings of the National Academy of Sciences of the United States of America.
“Debt causes significant psychological and cognitive impairment and alters decision-making,” the researchers observed. “However, debt has these effects not just because of the economic costs of holding debt, but because debt mental accounting creates bandwidth taxes that impair cognitive processes.”
Once borrowers had the resources they needed to understand debt and pay it down, their mindset changed.
“When people have resources, mental accounting may help motivate people to overcome their self-control problems and achieve outcomes that are genuinely welfare enhancing,” the study found.
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