Don't use personal loan for credit card debt

Steve BucciQuestionDear Debt Adviser,
Is it wise to get a personal loan of $17,000 to wipe out credit card debt? The cards have a maximum interest rate of 11.2 percent and my income is approximately $100,000 annually before taxes. I don't have a mortgage.
-- Ira

AnswerDear Ira,
Your credit card debt would not be "wiped out" with a personal loan; it would simply be shifted to another type of debt using a different credit instrument. Sort of like rearranging the deck chairs on the Titanic, your actions wouldn't materially change what's going to happen, although in your case it might make it worse. Here's why: Many personal loans have a payback period of no longer than 60 months, or five years. Credit cards tend to amortize your payment over eight to 10 years, resulting in a lower payment over a longer time. While many personal loans use a fixed rate, you can expect a rate of at least as much as you are paying, perhaps up to 22 percent. Again, a higher payment. Rather than move the debt around, I'd encourage you to do two things.

First, stop charging and determine why you have $17,000 in credit card debt with a take-home salary of approximately $75,000 per year. If you want to use credit for convenience, get a new card and don't carry a balance. That way you won't pay any interest on new purchases like you do now and you can concentrate on whittling down your $17,000 debt without new charges obscuring your progress. Based on your healthy income, unless you have enormously overspent in nonhousing areas, you should have plenty of discretionary income to purchase what you want or need without having to add to your card balance. So, let's start there.

If you don't already have one, create a spending plan. Track all of your expenses including daily and out-of-pocket purchases, such as lattes or cigarettes. Here are some national budget percentages of net income to help you see where you may be going over the top.

National budget averages
Average percent of income spent in each category:
Housing (mortgage or rent, real estate taxes)24 percent
Utilities (water, power, garbage collection)8 percent
Food14 percent
Clothing4 percent
Medical and health care6 percent
Donations and gifts to charity4 percent
Savings and insurance9 percent
Entertainment-recreation5 percent
Transportation (car payments, gas, service)14 percent
Personal, debt payments, misc.12 percent

Consider these as guidelines and expect your own personal budget will vary, but if the difference is huge, ask yourself why and if you might be better off cutting back in some areas. For example, you may live in an area where rent is super expensive, so that category may be more like 35 percent of your net income. But if your housing costs are more than 50 percent of your net income, you may need to look into making some living changes, such as getting a roommate or moving to a less-expensive place -- likewise, if your transportation costs are 30 percent of your net income. Realize that if you don't do something to change things, you may have to cut back elsewhere.

The goal of a spending plan is to enable you to make conscious decisions about where your money is spent and in the process help you attain your financial and personal goals. Once you have a workable spending plan in place, the second thing I want you to do is include paying off your credit card debt over the next two years (approximately $790 per month) in the plan. Do this while also setting aside some money in an emergency savings account. You will likely need to make adjustments to one or more other categories in order to accomplish this, but a short-term sacrifice will be worth it in the end.

Good luck!

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