When facing difficult financial circumstances, you may consider unconventional methods to pay off loans faster or consolidate debts. One option some people turn to is paying off loans using credit cards.
While this can provide short-term relief, it comes with considerable long-term risks. Paying loans with credit cards can easily lead you into deeper debt with spiraling interest costs if you are not extremely careful.
This article will examine why paying loans with credit cards is risky, potential dangers to be aware of, and how to minimize risks if you decide to go this route.
Why Paying Loans With Credit Cards is Risky
There are a few reasons why using credit cards to pay personal loans, auto loans, student loans and other installment debt is considered a risky financial move:
You Lose the Forced Discipline of a Loan
Loans have structured monthly payments that force you to pay down the balance over a fixed repayment term. This imposes financial discipline to ensure the debt gets repaid over time.
With a credit card, you have far more flexibility on payment amounts and timing. It is tempting to pay less than you were with the loan or skip payments occasionally. This lack of structure makes it more likely you will drag out repayment and accrue expensive credit card interest rates.
It’s Easy to Rely on the Card Again
Many people feel relieved when a burdensome loan is finally paid off by a credit card. However, now that the card has extra space on it, it becomes very easy to use that freed up credit for purchases again. This can quickly lead to a cycle of relying on credit cards again after paying off the loan.
Higher Interest Rates and Fees
Even if you have excellent credit, the interest rate will almost certainly be higher on a credit card compared to on a personal, auto, or student loan. The average credit card APR is around 16% while good credit loans can be 6-12%. Paying loans with a credit card means paying much higher interest.
Additionally, credit cards often have fees like annual fees, balance transfer fees, or cash advance fees. Loans generally do not have these added costs.
Credit Score Impacts
Aggressively paying down credit card balances can lower your credit utilization and help your credit scores. However, closing out an installment loan account also impacts your credit mix, which makes up 10% of a FICO score. This mixed effect makes credit score impacts uncertain.
Certain loans like home mortgages and student loans offer tax deductions for interest paid. You lose this potential tax benefit if refinancing those loans with a credit card.
Given these risks, you need a smart repayment strategy in place to minimize potential downsides.
Read More: How Balance Transfers Can Help Pay Off Loans
Dangers When Using Credit Cards for Loans
If you decide to use a credit card to pay off a loan, be aware of these common dangers that could wreck your finances:
Running Up More Credit Card Debt
It can be all too easy to rely on the credit card for additional purchases after paying off the loan. This can negate the entire purpose of paying off your debt and leave you in a worse financial position. Avoid charging anything else to the card until loans are paid off.
Paying the Minimum Only
Credit cards have minimum monthly payments, often around 2% of the balance. After paying off the loan, it’s tempting to only pay the minimum on the card. This will cause the principal balance to barely budge while interest charges accumulate.
Using the Freed Up Cash Irresponsibly
After eliminating a monthly loan payment, you suddenly have extra money each month in your budget. Instead of putting this cash towards the credit card balance, it’s easy to spend it on non-essential purchases. Be disciplined and use freed up cash to pay down balances.
Letting Balances Build on Multiple Cards
In the process of transferring a loan to a credit card, you may max out your credit limit on that card. Be careful not to then start transferring other loans or balances to additional cards. This can result in unmanageable balances across multiple cards.
Credit cards have variable monthly payments. It’s easy to lose track and miss making payments altogether when you no longer have a fixed loan payment due each month. Set payment reminders to avoid missed payments and late fees.
Using Cash Advances
If you don’t have enough available credit to fully pay off a loan, you may be tempted to take a credit card cash advance. This allows immediate access to cash but comes with fees and extremely high interest rates that build debt fast.
The risks of relying on credit cards to pay off loans are plentiful. Have precautions and planning in place or consider other options to avoid these pitfalls.
How to Minimize Risks When Paying Loans With Credit Cards
If you want to use a credit card strategically to pay off a loan, here are some tips to reduce potential risks and dangers:
- Pay off cards quickly – Have a plan to aggressively pay off the card within 6-12 months before interest racks up. Prioritize this over any other discretionary spending.
- Avoid additional card charges – Do not use the credit card for any purchases after transferring the loan balance until the card is paid off.
- Pay more than minimums – Pay well above the monthly minimum payment to reduce principal faster.
- Automate payments – Set up automatic payments from your bank account to the card for the monthly amount due to avoid missed payments.
- Track balances closely – Monitor your credit card balances and interest charges frequently to ensure your repayment plan is on track.
- Consolidate multiple balances carefully – Be cautious about transferring loan balances from multiple accounts onto one or more cards. This can be difficult to manage.
- Consider lower rate options – Explore whether a personal loan, balance transfer to a 0% APR card, or other options could reduce interest payments vs. using a credit card.
- Get professional help – Talk to a non-profit credit counselor if struggling to pay off credit card debt after loans. Don’t wait until it’s out of control.
Alternatives to Paying Loans With Credit Cards
Given the substantial risks that come with using credit cards to pay off loans, safer alternatives should be considered first:
- Debt consolidation loans – These combine multiple debts under a lower fixed interest rate.
- Home equity loan – Allows you to tap home equity at lower rates to pay off higher interest debt.
- 401(k) or retirement account loan – Lets you borrow against your own retirement savings temporarily.
- Balance transfer card – Transfer balances to a 0% intro APR card to save on interest for 12-18 months.
- Personal loan – Unsecured loans with fixed monthly payments at potentially lower rates than credit cards.
- Ask lenders for lower rates – Contact existing lenders directly to request lower interest rates to make payments more affordable.
- Credit counselling assistance – Get help negotiating with lenders for alternate repayment programs or interest reductions.
The Bottom Line
While paying loans with a credit card may seem like a quick fix, it comes with substantial financial hazards that can easily put you deeper in debt. Proceed with extreme caution, have a solid payoff plan, and explore safer alternatives before taking this high-risk approach.