When you’re carrying high credit card balances, interest on those monthly bills can build up faster than you can say APR (annual percentage rate). Making minimum payments, of course, barely makes a dent in your debt, so you may look to other ways to shift money around, such as using one credit card to pay for another. Unfortunately, this is rarely (if ever) a successful strategy. However, there may be another option: taking out a line of credit.
How to Pay Off a Credit Card with a Line of Credit
If you’re able to secure a personal line of credit at a lower interest rate than the interest rate you are currently paying on your individual credit cards, it could be a savvy financial strategy.
Let’s say you owe a total of $20,000 across four credit cards, each with annual percentage rates (APRs) of 20%. You’ll pay $4,000 in interest over the course of the year, for a total of $24,000. Now, if you can get a line of credit for $20,000 with a single-digit APR of 8%, you can pay off all four credit cards, and then make just one monthly payment to the new line of credit, which now totals $21,600 for the year, a savings of $2,400.
Sounds great, right? Well...maybe. As they say, "the proof is in the pudding" so let's first take a couple of steps back to make sure this is a strategy worth pursuing.
What is a Personal Line of Credit?
A personal line of credit is a predetermined loan that allows you to spend up to a certain amount. Unlike regular loans, there are no interest charges until you begin using it. Most people acquire personal lines of credit through their primary bank, which will verify your employment, income, and other financial factors, in addition to running a credit check to determine if you qualify. The higher your credit score is the lower your interest rate will likely be.
If you are able to secure a personal line of credit, you can use as much of it as you want, and pay back any amount you want, as long as you make the minimum monthly payment, which is usually a combination of interest and principal.
Is a Personal Line of Credit the Same as a HELOC?
Nope. Unlike a home equity line of credit (HELOC), a personal line of credit requires no collateral, so you won’t be in jeopardy of losing your home if you default. However, because the bank is offering the line of credit unsecured, they will determine how much you can get (and how much your interest rate will be) based solely on your credit score.
Unfortunately, many people struggling with debt may not have a stellar credit score. If you have accounts in collections or you are consistently late in making your monthly payments, you’re likely to be denied a personal line of credit.
How Much Credit Can I Get?
Most personal lines of credit range from $5,000 to $50,000, but if you qualify for more than your current debt load, don’t give into the temptation! Only take out a line of credit for the amount of your total credit card debt. So, if you have three credit cards and you owe $10,000, $7,000 and $3,000 on them, try to acquire a personal line of credit of no more than $20,000 to pay those credit cards off in one fell swoop. Then you can focus on simply paying back the personal line of credit at a much lower interest rate than what you were paying on your credit cards.
What is the Interest Rate on a Line of Credit?
Aside from consolidating your debt into one convenient monthly payment versus many, this is where a personal line of credit can really pay off. Lines of credit usually come with a significantly lower interest rate than credit cards. You might even be able to get a line of credit with a single digit percentage interest rate such as 8% versus the average credit card rate of nearly 20%.
It’s important to note that interest rates for lines of credit are variable, meaning they change depending on the bank’s prime rate. So, if you borrow when rates are low, it can come back to bite you if the rates go up by the time you start repaying. Therefore, if the difference in interest rate between your credit cards and a line of credit is less than 3%, it might not be worth it.
A Word of Caution About Lines of Credit
If you thought at the start of this blog, “Isn’t it counterproductive to pay off debt by taking on more debt?” you may have a point, especially if you don't have good spending control. We’ve seen clients obtain a personal line of credit to pay off their credit card debt, but then rack up charges on their credit cards again, leaving them in a much worse predicament. Not only do they have to pay back the personal line of credit, but now also the new charges on their cards.
So, if you are able to obtain a line of credit, end the spiral of debt and put away the credit cards for good — or at least until the line of credit is completely paid off.
Denied a Line of Credit?
Again, many people struggling with debt have a spotty credit report and a low credit score, which can make it next to impossible to obtain a line of credit at a decent interest rate. Luckily, there are other options, such as a Debt Consolidation Program (DCP) through a non-profit credit counselling agency, like Credit Canada. With a DCP, your debts are rolled into one monthly payment and a certified Credit Counsellor will negotiate with your creditors on your behalf to stop or reduce interest charges. They will also help you pay off your debt over time while teaching you valuable money management skills to keep you living debt-free for good.
If a DCP sounds like the right fit for you, or if you just need some advice regarding your debt, the experts at Credit Canada are just a phone call away. Our debt counselling sessions are 100% free, confidential, and non-judgmental. Just call 1.800.267.2272 to book! You'll get all the information you need to make the best decision for you and your financial future.