Could a Debt Consolidation Loan Solve Jane Doe's $34,467 Credit Card Debt Problem?
When someone is overwhelmed by high-interest credit card debt, a debt consolidation loan can sound like the perfect solution. Take out one personal loan, pay off the credit cards, replace several monthly payments with one payment, and hopefully reduce the interest rate.
At least, that is how debt consolidation is often presented.
But what happens when we apply that strategy to a realistic household financial situation?
Meet Jane Doe. Jane has $34,467 in credit card debt, an average credit card interest rate of 24.52%, and a hypothetical credit score of 675. She is struggling to make her payments even though her household brings in more than $8,400 per month.
In this series, we will follow Jane through several different ways of dealing with her credit card debt. Each option will be evaluated based on the good, the bad and the ugly before receiving an overall grade.
First up: using a personal loan as a debt consolidation loan.
Meet Jane Doe
Jane's financial problems are not simply the result of having a low income. Her household brings home approximately $8,441.86 per month, but her reported monthly expenses are approximately $8,686.
That means Jane is already running approximately $244 short every month before dealing with emergencies, unexpected repairs, medical expenses or other unplanned costs.
Jane's Monthly Expenses
A large portion of Jane's income is already committed before she has an opportunity to build savings or make additional payments toward her debt.
| Expense Category | Monthly Amount | Percentage of Income |
|---|---|---|
| Housing | $2,474 | 29.3% |
| Food / Groceries | $1,250 | 14.8% |
| Debt Payments | $2,925 | 34.6% |
| Auto | $672 | 8.0% |
| Insurance | $430 | 5.1% |
| School / Childcare | $200 | 2.4% |
| Clothing & Gifts | $80 | 0.9% |
| Savings / Investments | $25 | 0.3% |
| Entertainment | $630 | 7.5% |
One of Jane's biggest problems: debt payments consume approximately 34.6% of her monthly income while only $25 per month is being directed toward savings and investments.
Jane Has More Than Just Credit Card Debt
Jane's $34,467 of credit card debt is only part of her financial picture. Her household also has mortgage debt, vehicle debt, student loans and other financial obligations.
That matters because a lender evaluating Jane for a large debt consolidation loan will generally look beyond her credit score. Existing monthly obligations and overall debt can affect both approval and the interest rate offered.
$34,467 of Credit Card Debt at 24.52% APR
For this case study, we are focusing on five credit card accounts totaling $34,467.
Those accounts carry an average interest rate of 24.52%. Jane is currently paying approximately $1,223 per month toward these cards.
At the current balances and interest rates, approximately $704 per month is being consumed by interest and fees. Only about $519 of Jane's monthly payments are reducing principal.
What Happens If Jane Gets a Debt Consolidation Loan?
Jane decides to investigate a debt consolidation loan. Her goal is straightforward: borrow enough money through an unsecured personal loan to completely pay off the $34,467 she owes on her credit cards.
Instead of making payments to several credit card companies, Jane would make one monthly payment on the new personal loan.
For purposes of this example, let's assume Jane qualifies for a personal loan at 18% APR.
An 18% rate is clearly better than 24.52%. However, Jane's hypothetical loan also comes with a 4% origination fee.
Depending on how the lender structures the origination fee, Jane may need to borrow more than $34,467 to completely pay off her cards.
The Consumer Financial Protection Bureau notes that personal installment loans can include costs such as origination fees and recommends reviewing the lender's loan disclosures before agreeing to the loan. Learn more about personal loan fees from the CFPB .
The Good: Jane's Credit Cards Are Paid Off
There are genuine advantages to using a debt consolidation loan to pay off high-interest credit cards.
The most obvious benefit is that Jane's targeted credit card balances can immediately drop to $0.
Instead of juggling several credit card payments, due dates and interest rates, Jane has one personal loan and one scheduled payment.
The Debt Consolidation Loan Lowers Jane's Interest Rate
Jane's average credit card APR is 24.52%. Moving that debt to an 18% personal loan reduces the interest rate by more than six percentage points.
That doesn't make the debt inexpensive, but it does mean less interest should accumulate than if Jane continued carrying the same balances at 24.52%, assuming she does not add additional debt.
She Gets a Defined Payoff Schedule
Credit cards are revolving accounts. A borrower can continue using them while making minimum payments, which can dramatically extend the time it takes to become debt free.
A fixed-rate personal loan gives Jane a scheduled monthly payment and a defined loan term. As long as she makes the required payments, she knows when the loan should be paid off.
Her 675 Credit Score May Not Take a Major Immediate Hit
Jane may experience a temporary credit impact from applying for and opening a new account. At the same time, paying off large revolving credit card balances could substantially reduce her credit utilization.
Unlike some other debt-relief strategies, Jane does not have to intentionally stop paying her creditors in order to use a consolidation loan.
The Good:
- Jane's targeted credit card balances are paid in full.
- Her average interest rate falls from 24.52% to approximately 18%.
- She replaces multiple card payments with one personal loan payment.
- She receives a defined repayment schedule.
- She doesn't have to intentionally fall behind on her credit cards.
- Her credit score may experience only a relatively modest short-term impact.
The Bad: Qualifying for a Large Debt Consolidation Loan Could Be Difficult
A credit score is only one part of a personal loan application.
Jane has a hypothetical credit score of 675, but she also has substantial existing financial obligations and a budget that is already running at a monthly deficit.
Her financial analysis calculated a debt-to-income ratio of approximately 52.90%. That could make obtaining a large unsecured personal loan more difficult.
Jane Might Not Receive Enough Money
Jane needs at least $34,467 to completely eliminate the targeted credit card balances. Depending on how an origination fee is handled, she may need even more.
But what if a lender approves Jane for only $15,000, $20,000 or $25,000?
Jane could end up with both a new personal loan and remaining credit card balances.
Instead of simplifying her financial situation, she may simply rearrange it.
An 18% Debt Consolidation Loan Is Still Expensive
Moving from 24.52% to 18% represents meaningful savings, but an 18% personal loan is still high-interest debt.
Jane isn't moving from expensive credit card debt to inexpensive debt. She is moving from very expensive debt to somewhat less expensive debt.
The Origination Fee Makes the Loan More Expensive
Jane's hypothetical 4% origination fee equals approximately $1,379.
If that fee is financed, the amount Jane owes could increase to approximately $35,846. If the lender instead deducts the fee from the proceeds, Jane may not receive enough cash to completely pay off the $34,467 she owes unless she borrows additional money.
The CFPB also warns consumers to consider the full cost of consolidation. A lower monthly payment can sometimes result from a longer repayment term, which may increase the total amount paid over time. Read the CFPB's guidance on consolidating credit card debt .
The Ugly: The Debt Consolidation Loan Doesn't Fix Jane's Spending Problem
This is the biggest weakness in Jane's debt consolidation strategy.
Her credit cards may now show zero balances, but what has changed about Jane's monthly budget?
Potentially nothing.
Jane was already spending approximately $244 more each month than she earns. Simply moving debt from credit cards to a personal loan doesn't automatically correct that cash-flow problem.
And now Jane has something that can become very tempting:
What Happens If Jane Starts Using the Credit Cards Again?
Imagine Jane takes out the consolidation loan and pays off all five cards. For the first few months, everything goes according to plan.
Then her car needs an unexpected repair.
Jane charges $1,500.
The holidays arrive and another $2,000 goes on the cards. Groceries cost more than expected. An appliance breaks. A family expense comes up.
Before long, Jane could have several thousand dollars of credit card balances again.
Except this time she also has the personal loan.
How Debt Consolidation Can Become Debt Accumulation
Jane's starting credit card debt: $34,467
She consolidates it into a personal loan of approximately $35,846, assuming the hypothetical 4% fee is financed.
Later, Jane accumulates another $8,000 on her newly available credit cards.
The exact loan balance would depend on how many payments Jane had already made, but the underlying problem is the same.
Debt consolidation only works if the debt stays consolidated.
A Debt Consolidation Loan Changes the Debt, Not Necessarily the Behavior
Jane's problem isn't exclusively that her credit cards charge 24.52%. The high interest rate is certainly hurting her, but her budget also shows that expenses exceed income.
Unless Jane reduces spending, increases income, or does some combination of both, she may continue relying on credit to cover the monthly shortfall.
The CFPB makes a similar point in its consumer guidance: taking on new debt to pay off old debt may not solve the problem when the underlying issue is that expenses continue to exceed income.
A lower interest rate can help solve a mathematical problem. It cannot, by itself, solve a spending problem.
The Good, The Bad and The Ugly
The Good
Jane's $34,467 in targeted credit card debt is paid off. Her rate falls from 24.52% to approximately 18%, she has one scheduled payment, and the immediate effect on her 675 credit score may be relatively modest.
The Bad
Qualifying for enough money could be difficult. The 18% rate is still expensive, and a hypothetical 4% origination fee adds approximately $1,379 to the transaction.
The Ugly
Jane hasn't corrected her negative cash flow or spending habits. If she starts using the paid-off cards again, she could end up owing both the personal loan and thousands of dollars in new credit card debt.
A Debt Consolidation Loan Doesn't Automatically Fix a Budget
Jane's monthly numbers help explain why a debt consolidation loan receives a relatively low grade in this particular case.
Jane is starting the process with a monthly deficit. Unless the new loan payment creates enough savings to completely eliminate that deficit — and Jane avoids accumulating additional debt — she remains financially vulnerable.
That's why successful debt consolidation usually requires more than getting approved for a loan. It also requires a realistic spending plan and a commitment to avoid rebuilding balances on the credit cards that were just paid off.
Before Taking Out a Debt Consolidation Loan, Review the Alternatives
A personal loan is only one possible way to deal with high-interest credit card debt. Before borrowing more money, it can help to compare the numbers under several repayment strategies.
DebtWave Resources
- Use DebtWave's Credit Card Payoff Calculator to estimate how long your existing balances could take to repay.
- Compare a potential repayment plan using the Debt Management Plan Calculator .
- If credit card payments are becoming difficult to manage, learn more about getting help with credit card debt .
How Does a Debt Consolidation Loan Compare With Jane's Other Options?
Throughout this series, Jane's same basic financial situation will be evaluated using several different approaches to paying off credit card debt.
| Debt Relief Option to Pay Off Credit Card Debt | Grade |
|---|---|
| Personal Loan (Debt Consolidation Loan) | D+ |
| Balance Transfer | C- |
| Withdrawing Money From a 401(k) | F |
| Taking a Loan From a 401(k) | D- |
| Credit Counseling & Debt Management Plan | A |
| Debt Settlement | D- |
| Credit Card Hardship Programs | B+ |
| Borrowing Money From a Friend or Family Member | D |
| Filing Chapter 7 Bankruptcy | D- |
| Filing Chapter 13 Bankruptcy | F |
The grades in this series are specific to Jane's hypothetical financial situation. A debt-relief strategy that receives a low grade for Jane could be much more appropriate for someone with a different income, debt level, credit profile or monthly budget.
Debt Consolidation Loan: D+
A debt consolidation loan isn't necessarily a bad financial product. For the right borrower, it can be an effective way to replace high-interest revolving debt with a lower-rate installment loan.
But we're not grading debt consolidation in general. We're grading it for Jane.
Jane needs to borrow more than $34,000. She already has substantial debt obligations, negative monthly cash flow and a hypothetical credit score of 675. Even if she qualifies, we're assuming her new interest rate is still 18%.
Most importantly, paying off Jane's credit cards does not automatically solve the spending and cash-flow problems that contributed to the debt.
With thousands of dollars in newly available credit, Jane could easily start charging again and eventually find herself with a personal loan and new credit card balances.
The debt consolidation loan improves Jane's interest rate and simplifies her payments, but it does not adequately address the underlying financial problem.
Overall Grade: D+
Should Jane Use a Debt Consolidation Loan?
Jane's situation illustrates why a debt consolidation loan should be evaluated as more than an interest-rate comparison.
A lower rate is valuable. One monthly payment can be convenient. Paying off multiple credit cards can also provide an immediate sense of progress.
But those benefits only matter if the new loan fits within the borrower's budget and the paid-off credit cards remain paid off.
Before choosing a debt consolidation loan, someone in Jane's situation should look closely at the new APR, origination fees, monthly payment, repayment period, existing debt obligations and the likelihood that they will rely on their credit cards again.
Most importantly, the household budget needs to work after the consolidation. Moving debt from one place to another isn't the same thing as eliminating it.
Important: Jane Doe is a hypothetical case-study name used for educational purposes. The financial figures in this example are based on a sample financial analysis, with certain facts adjusted for this series. Loan approvals, interest rates, fees, credit-score changes and repayment outcomes vary by borrower and lender. This article is for educational purposes and should not be interpreted as a guarantee of loan approval, credit-score results or financial savings.