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The widening spread between interest rates on credit cards and personal loans could open up opportunities for consumers who ran up their credit card balances during the coronavirus crisis to consolidate that debt at lower rates.

According to the latest Federal Reserve data, borrowers who were charged interest on their credit cards paid 16.61% interest, on average, during the first three months of 2020. The average rate on personal loans was considerably lower, at 9.63%.

That’s a difference of 6.98 percentage points — the biggest “spread” between interest rates on credit cards and personal loans in Federal Reserve records dating back to 1998.

Savings from consolidating credit card debt

Qualifying borrowers can pay off their credit card balances by taking out a personal loan at a lower interest rate, potentially saving thousands of dollars.

Consolidating credit card and other debt is the most common reason consumers cite when using the Credible marketplace to request rates and take out personal loans.

An analysis of borrowers using the Credible marketplace to take out personal loans to pay off credit cards and other debt found that, among borrowers with credit scores in the 720 to 779 range taking out 3-year personal loans during May:

  • The median interest rate was 8.99%
  • The median debt consolidated was $18,000
  • The potential savings from refinancing was $2,374, based on the median debt consolidated and average credit card interest rate of 16.61%

Data from the Credible marketplace shows that borrowers with fair credit (640 or higher) may also be able to save money by consolidating credit card debt if they’re paying above-average rates on their credit cards.

Debt boom-bust cycle

Credit card debt tends to rise when the economy is booming, but may not peak until after a recession is well underway. During the Great Recession that stretched from December 2007 to June 2009, outstanding credit card balances peaked during the fourth quarter of 2008 at $870 billion, a record high at the time.

At the end of 2019, Americans had a record $930 billion in credit card debt, up 41% from the $660 billion owed at the end of the first quarter of 2014.

Impact on credit score

Consolidating credit card debt with a personal loan can improve your credit score in three ways:

  • By reducing the overall amount of debt you owe (if you don’t run up more debt on your credit cards)
  • Lowering your credit utilization ratio (the percentage of your available credit limit you’re accessing on each credit card)
  • Improving your credit mix: If you don’t have a history of making car payments or another installment loan on your credit record, adding a personal loan to your credit mix can boost your credit score

Just keep in mind that those benefits can be undone if you run up more debt on your credit cards, or can’t keep up with the payments on your personal loan.

A 2017 academic study by researchers at the Georgia Tech Scheller College of Business found that when borrowers took out personal loans to pay off credit card debt, their credit scores increased by an average of 21 points.

But many also saw their credit card limits increased, and it was not unusual for borrowers to start racking up new debt on their credit cards in just a few months. After two years, the group studied had higher average debt levels than when they started and were at a higher risk of default.

The new FICO 10 and FICO 10T credit scores will penalize borrowers who consolidate debt with personal loans if they proceed to rack up even more debt.

Methodology: Median rates based on a sample of loans made to borrowers seeking to consolidate credit card and other debt through the Credible marketplace during May, 2020. Savings estimate based on the median loan balance of $18,000 for borrowers with credit scores in the 720 to 779 range who took out loans with a 3-year repayment term.

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About the author
Matt Carter
Matt Carter

Matt Carter is an expert on student loans. Analysis pieces he’s contributed to have been featured by CNBC, CNN Money, USA Today, The New York Times, The Wall Street Journal and The Washington Post.

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