Personal-loan rates are half credit-card APRs. Is now the time to consolidate?

The almost 11.5% 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, according to Federal Reserve statistics through May. Of course, some personal-loan rates can go to the mid-20% range or even higher, depending on the lender.

All of this debt is coming at a bad time. Pandemic-era excess savings are running out, and federal student-loan payments will resume in October. One solution: a personal loan to consolidate credit-card debt could be a way to relieve the pressure.

The first — and perhaps obvious — question to ask: do you have a good credit score? This is key for those who wish to land a loan from a bank or fintech that has an interest rate lower than a credit-credit card interest rate. It’s possible to achieve this even when so many interest rates are climbing.

Credit-card debt consolidators were able to slash nearly half of their balances on average and improve their credit score by 18 points between April 2021 and September 2022, according to research released last week from TransUnion
TRU,
+1.15%,
one of the three big credit bureaus along with Experian
EXPGF,
-0.45%
and Equifax
EFX,
+0.78%.

But old habits may resurface among many of the consumers involved in the study. “For many credit card debt consolidators, those balances returned close to their previous levels 18 months later,” the report added.

“Consolidating credit-card debt into an unsecured personal loan can be a good option to pay your debt off while freeing up funds in your monthly budget,” Margaret Poe, head of consumer credit education at TransUnion, said in the report. “However, it’s important to pair this with changes in spending habits to ensure that the credit-card debt doesn’t return.”

Other research also shows consolidating pays off. The credit scores of people using personal loans to pay their card balances jumped 30 points, according to a separate LendingTree study also released last week. Three months later, those scores drifted to an average 22-point increase.

But it’s not for the faint of heart. “You have to be careful and very disciplined in this approach,” said Bruce McClary, spokesman for the National Foundation for Credit Counseling, an association of nonprofit credit counseling services. 

What personal-loan rates can you expect?

As of early August, three-year loans averaged 15.04%, up from 10.65% a year ago, according to Credible, an online platform that compares interest rates and offers. Five-year loans averaged 18.84%, up from around 15% a year ago.

These high rates have deterred many consumers. Lenders originated 4.2 million personal loans in the first quarter of the year, more than 18% below the previous quarter and down 15.5% year over year, TransUnion said.

But the first quarter of 2022 was a period of “unprecedented growth,” where lenders were speeding up originations after the worst days of the pandemic, said Liz Pagel, senior vice president and consumer lending business leader at TransUnion.

As inflation surged, lenders pulled back on personal-loan offers, Pagel said. “This is due to being worried about the economy, and also due to decreased demand from the investors that typically buy these loans, many of which are waiting for a more certain economy.”

Then came the banking crisis, starting with Silicon Valley Bank’s failure last March. Lenders have continued tightening their standards even more. Rejections for mortgages, car loans and credit cards have reached a five-year high, according to the Federal Reserve Bank of New York.

Credit scores also matter. When someone with a prime credit score — 661 to 720 — got a new credit card in the fourth quarter of last year, the median APR was 19.8%, TransUnion said. If they took out a personal loan at the same time, the median interest rate was 15.9%.

But if someone with a lower credit score — 601 to 660 — took out a new credit card at the end of last year, they could expect to pay a much higher median APR of 20.2%, and a median interest rate of 24.2% on personal loans, TransUnion added.

When does it make sense to consolidate debt?

Before considering a personal loan, try a 0% balance transfer card, said Matt Schulz, chief credit analyst at LendingTree. “If you have good credit and you can get a 0% balance transfer, that’s probably a better option than a personal loan,” he said.

Whatever way you cut it, a personal loan will not give you a 0% offer. “That’s pretty darn hard to beat,” he said. The caveat: there’s typically a one-time fee anywhere between 3% and 5% of the transferred balance, he noted.

Another warning: Introductory 0% rates last for a limited time only. APRs kick in that can be somewhat higher than other credit-card offers. That means higher penalties if the cardholder is unable to pay their full balance once the 0% rate expires.

People can make minimum monthly payments on credit cards, even though that’s costly and — therefore — not advisable. They cannot make minimum payments on a loan. “Unlike a personal line of credit, there’s a date certain when the loan is paid,” McClary said.

The extra spending power a consumer may receive from consolidating their credit-card debt into a personal loan could contribute to a rise in their credit score or, conversely, lead that person to resume spending beyond their household budget. 

Before taking out a personal loan to pay their credit-card debts, TransUnion said consumers featured in its research were using a median 59% of their credit limit, but that fell to 42% of their credit-card limit 18 months later. 

“As great as it can be to streamline things and only pay one bill instead of three or four,” Schulz said, “you still have to make sure you are comfortable making that new payment on that new personal loan so you don’t end up in a more difficult situation than you are already in.”