How to Use a Credit Card to Pay Off a Loan
If you are carrying a balance on a credit card as well as a personal loan or car loan, it may be difficult to keep up with the payments each month. One option is to pay off your loan with your credit card. However, there are a number of things to consider before reaching this decision.
First, you will want to make sure the interest rate on your credit card is lower than the interest rate on your car loan or personal loan. In the case of the automobile loan, it is unlikely your credit card has a lower interest rate. Since car loans are a secured debt—meaning the bank can repossess your car if you fail to make payments—they generally carry lower interest rates. Generally speaking, personal loans also have lower interest rates. Thus, if your credit card has a higher interest rate than your other loans, it does not make sense to transfer this debt to your credit card, even though it will mean fewer payments each month.
One exception to this rule could be if you are offered a credit card with a 0% introductory interest rate. In this case, it may be a good idea to pay off the balances of your other loans with this credit card. You could be saving a significant amount of interest. However, it is important to know the 0% intro rate will only be offered for a short period of time, and then the interest rate will substantially increase. If you do decide to pay off your loan with a 0% interest rate card, make sure you have a realistic plan in place for paying off the debt before that introductory period is over.
Even if your card offers a 0% APR, you will likely be charged fees (usually 3% to 5%) to transfer the balance of your loan to your credit card. There are a number of calculators online to help you determine whether you can save money transferring your balance after factoring in these associated fees.
To possibly avoid a balance transfer fee, you can call your loan servicer and ask if they can take a credit card payment over the phone. If they are able to accept payment this way, you will not be charged a fee because the transaction will be considered a purchase. However, most loan services only allow cash-backed payments, such as check, money order, direct transfer from your personal bank or debit card.
One pitfall to avoid is taking out a cash advance to pay your loan. These are never covered under 0% introductory interest rates, so you will be charged a cash advance fee. In addition, the interest rate on a cash advance is typically extremely high, usually 25.99%, much steeper than the traditional interest rate on a car or personal loan.
Your Credit Score
It is important to determine whether transferring a balance from a loan to your credit card will save you money on interest, but there is another consideration. You need to realize your credit score may be negatively impacted by the transaction. When you pay off your loan, this will positively impact your credit. However, moving loan debt to a credit card will also increase your credit utilization, which is the second-most important factor in determining your credit score.
When you pay off your loan, this will close the account, and you will no longer have access to that credit. Additionally, you will be using more of the credit available on your credit cards. If you are using more than 30% of your available credit, your score will be negatively impacted.
Only you can weigh each factor to determine the soundest decision in your situation, but it is important not to make rash decision when it comes to your credit.