Should You Pay Off Outstanding Balance On Your Credit Card By Taking A Personal Loan

These are times with many choices. Here's just one other choice that many of you might be pondering over – should you shift to a personal loan to pay off your credit card dues? Raghu has the same question.

Let's understand Raghu's situation in life. He has Rs 60,000 as outstanding on his credit card, on which he pays interest at the rate of 3.14 per cent a month. His present financial situation allows him to pay only Rs 5,000 a month from his salary to clear the amount. His bank has offered him a personal loan at a rate of 18 per cent per annum.

So, should Raghu continue with the existing payment on his card or should he switch to the loan?

Yes, of course. Here's why:

There are two parts to the analysis:

• The first, determines the cost incurred on account of the existing credit card interest.
• The second, computes the new cost under the personal loan.

Action:
Shift only if, the cost incurred on taking a personal loan is lesser than the cost on credit card interest.

This requires a complete look at the position over the entire period of 12 months when the payment will be done to clear off the outstanding amount. To keep calculations simple, we are not taking any additional costs like processing fee or such similar amount for the personal loan into consideration.

Cost incurred on credit card

The credit card cost will have Rs 60,000 plus the interest that is piling up. He can choose to repay in two ways:

A. If Raghu decides to pay the interest in the final installment, then by the end of 12 months he will have to pay an additional Rs 15,425 (total interest after adjusting Rs 5,000 per month).

This figure is high because the interest keeps piling up each month and at the same time he needs to incur interest on this amount as well.

Total interest outflow: Rs 15,425

B. If Raghu pays off the entire interest cost incurred each month along with the monthly installment on his credit card, he'd then pay Rs 6,884 in the first month which will go down each month as the capital is also paid off. This becomes Rs 6,099 in the sixth month and finally Rs 5,314 in the last month, totaling Rs 72,246.

Total interest outflow: Rs 12,246

Personal loan

Shifting the amount to a personal loan involves taking the loan from the bank and using it to pay off the existing outstanding.

In the case of personal loan, the EMI is Rs 5,500 (when you have to repay within a year at an interest rate of 18 per cent). Here, he cannot pay the interest at a later date as it is already included in the equated monthly installment figure.

Total interest outflow: Rs 6,000

In conclusion

Raghu is better off taking the personal loan because the interest outflow is the least. The dynamics could change if the rate of interest on the personal loan is much higher than 3.14 per cent per month. But that is far flung. Most of the times, personal loans do work out cheaper than credit cards.

Do a similar working before making your decision to switch. Analysis is the key to smart saving.