Paying Off Credit Card Debt with Line of Credit

When you’re carrying high credit card balances, interest on those monthly bills can build up faster than you can say APR (annual percentage rate). Making minimum payments, of course, barely makes a dent in your debt, so you may look to other ways to shift money around, such as using one credit card to pay for another. Unfortunately, this is rarely (if ever) a successful strategy. However, there may be another option: taking out a line of credit.

If you’re wondering whether you should use your line of credit to pay your credit card debt, the answer depends on your specific financial situation, as well as the rates and terms of different financial providers. Discover the risks and benefits of a line of credit and explore alternative solutions for eliminating your credit card debt once and for all. 

Understanding Lines of Credit and Credit Cards

If you’re able to secure a personal line of credit at a lower interest rate than the interest rate you are currently paying on your individual credit cards, it could be a savvy financial strategy.

Let’s say you owe a total of $20,000 across four credit cards, each with annual percentage rates (APRs) of 20%. You’ll pay $4,000 in interest over the course of the year. Now, if you can get a line of credit for $20,000 with a single-digit APR of 8%, you can pay off all four credit cards and then make just one monthly payment to the new line of credit, with an interest of $1600 for the year. That’s savings of $2,400. 

Sounds great, right? Well…maybe. As they say, “the proof is in the pudding” so let’s first take a couple of steps back to make sure this is a strategy worth pursuing.

What is a Personal Line of Credit?

A personal line of credit is a predetermined loan that allows you to spend up to a certain amount. Unlike regular loans, there are no interest charges until you begin using it. Most people acquire personal lines of credit through their primary bank, which will verify your employment, income, and other financial factors, in addition to running a credit check to determine if you qualify. The higher your credit score is, the lower your interest rate will likely be.

If you are able to secure a personal line of credit, you can use as much of it as you want, and pay back any amount you want, as long as you make the minimum monthly payment, which is usually a combination of interest and principal.

Is a Personal Line of Credit the Same as a HELOC?

Nope. Unlike a home equity line of credit (HELOC), a personal line of credit requires no collateral, so you won’t be in jeopardy of losing your home if you default. However, because the bank is offering the line of credit unsecured, they will determine how much you can get (and interest rate) based on your credit score, job stability, income, and total debt service (TDS) which is the percentage of your monthly household income that covers your housing costs and other debts.

Unfortunately, many people struggling with debt may not have a stellar credit score. If you have accounts in collections or you are consistently late in making your monthly payments, you’re likely to be denied a personal line of credit.

How Much Credit Can I Get?

Most personal lines of credit range from $5,000 to $50,000, but if you qualify for more than your current debt load, don’t give into the temptation! Only take out a line of credit for the amount of your total credit card debt. So, if you have three credit cards and you owe $10,000, $7,000, and $3,000 on them, try to acquire a personal line of credit of no more than $20,000 to pay those credit cards off in one fell swoop. Then you can focus on simply paying back the personal line of credit at a much lower interest rate than what you were paying on your credit cards.

Comparing Lines of Credit With Credit Cards

Aside from consolidating your debt into one convenient monthly payment versus many, this is where a personal line of credit can really pay off. Lines of credit usually come with a significantly lower interest rate than credit cards. You might even be able to get a line of credit with a single-digit percentage interest rate such as 8% versus the average credit card rate of nearly 20%.

It’s important to note that interest rates for lines of credit are variable, meaning they change depending on the bank’s prime rate. So, if you borrow when rates are low, it can come back to bite you if the rates go up by the time you start repaying. Therefore, if the difference in interest rate between your credit cards and a line of credit is less than 3%, it might not be worth it.

“Paying credit card debt with a line of credit can really lower your interest charges on a monthly basis, but there are some potential downsides with the availability of new credit.  You may want to consider lowering the limits on your existing credit cards or even closing some of the cards completely to prevent yourself from going further into debt in the future.”

Craig Stewart, Credit Counsellor, Credit Canada 

Pros and Cons of Using a Line of Credit to Pay Credit Card Debt

If a line of credit offers low interest rates and a high credit limit, doesn’t it make sense to use a line of credit to pay off your existing credit card debt? Maybe. But before you open up a new line of credit, it’s wise to weigh the pros and cons of paying your credit card with a line of credit.

Pros

On the plus side, using a line of credit can offer such benefits as:

• Lower interest rates than your credit card: For qualified borrowers, interest rates can be significantly less for a line of credit 
• Flexible repayment options: Lenders may have varied structures that they can set up for repayment plans
• Potential to raise your credit score: By adding in other kinds of credit to your mix, rather than only having credit cards, your credit score may go up if you stay up on your payments

Basically, you’d be using your line of credit to replace one or more of your credit card bills, which makes this a great option for debt consolidation.

Does Paying Off a Credit Card With a Line of Credit Affect Your Credit Score?

Paying off a credit card with a line of credit can positively affect your credit score as long as you make consistent payments according to your payment schedule. A line of credit will even make it easier to keep up with these payments since you’ll be paying less in overall interest.

Cons

There are some drawbacks to using a line of credit to manage credit card debt. You might see disadvantages like:

• Accumulating more debt: If you use a line of credit to pay for a credit card balance but continue to use that credit card, you could end up with more debt than you can handle
• Raising your credit utilization ratio: If your credit utilization ratio (the ratio of credit usage to credit limits) gets too high, it can negatively impact your credit score
• Incurring additional fees and penalties: A line of credit may come with its own fees and penalties, which may be higher than the ones on your credit card balance

Some lines of credit (including a HELOC) are also considered secured loans. This means you’ll put up your property, such as your house, as collateral. If you can’t afford to repay your loan, you risk losing your home.

When Does It Make Sense to Use a Line of Credit?

Knowing how to use line of credit to pay off credit card debt can help you in the following situations:

• Your line of credit offers lower interest rates than your high-interest credit card. For example, your line of credit offers an 8% interest rate vs. your credit card’s 20%.
• You have sufficient income to manage your line of credit payments and aren’t simply taking on more debt without a repayment plan.
• You need a larger line of credit for major purchases than what you already have available through your credit cards.

A line of credit can also give you more flexibility for funding projects (such as a home remodel) than other financing options. For example, a home equity loan offers cash in a lump sum, but a line of credit offers some wiggle room for projects with an uncertain budget. Even better, you’ll only pay interest on the money you actually borrow. 

For example, if you have a line of credit worth $20,000 at 8% interest and spend only $17,000, you will only owe the interest on the $17,000 — not the full $20,000 you were eligible to borrow.

For best results, always compare the interest rates of at least three providers. This will ensure you get the best interest rates, terms, and overall value for your line of credit.

When You Should Avoid Using a Line of Credit

It’s not always a good idea to use a line of credit. It can be a viable option when you find favourable interest rates and terms, but there may be times when it’s best to avoid using a line of credit to cover existing debts.

For example, you should avoid using a line of credit if:

• You lack a stable income to manage payments
• You have a high existing line of credit balance
• Your credit score restricts you from gaining favorable interest rates and terms

In these scenarios, a line of credit might only deepen your debt and potentially damage your credit score if you can’t make timely payments. It’s important to consider your cash flow before taking on this new debt. Otherwise, you could only make your financial situation even worse.

A Word of Caution About Using Lines of Credit to Pay Off Debt

It may seem counterproductive to pay off debt by taking on more debt, and you may have a point—especially if you don’t have good spending control. We’ve seen clients obtain a personal line of credit to pay off their credit card debt, but then rack up charges on their credit cards again, leaving them in a much worse predicament. Not only do they have to pay back the personal line of credit, but now also the new charges on their cards.

So, if you are able to obtain a line of credit, end the spiral of debt and put away the credit cards for good — or at least until the line of credit is completely paid off.

That said, it’s important to avoid making mistakes when using a line of credit. Here are some of the most common mistakes people make when using a line of credit to pay off credit card debt:

• Not comparing to find the lowest interest rate
• Failing to address the spending habits that created the problem to begin with
• Overlooking the impact of fees or penalties
• Using the line of credit for non-essential purchases
• Failing to make timely payments 

Not only can these mistakes deepen your existing debt, but they can also damage your credit if you don’t keep up with your payment schedule. For these reasons, combining a line of credit with a broader approach to your finances is important.

Create a household budget, cut out unnecessary expenses, and take steps to pay your bills on time, such as automating your payments. Steps like these can help you get out of debt and stay there once you eliminate your existing obligations.

Alternatives to Using a Line of Credit

Again, many people struggling with debt have a spotty credit report and a low credit score, which can make it next to impossible to obtain a line of credit at a decent interest rate. Luckily, there are other options to help you pay off your debt. Here are some alternatives to using a line of credit to manage credit card debt.

Debt Consolidation Programs

You risk severe financial consequences if you can’t pay your credit card bills. That’s why some people choose to use a debt consolidation program. This solution will not only help you manage your debt but may reduce the total amount you owe. 

Debt Consolidation Programs (DCP) are offered through non-profit credit counselling agencies like Credit Canada. With a DCP, your debts are rolled into one monthly payment and a certified Credit Counsellor will negotiate with your creditors on your behalf to stop or reduce interest charges. They will also help you pay off your debt over time while teaching you valuable money management skills to keep you living debt-free for good.

Balance Transfer Card

Many credit card providers offer what’s known as a balance transfer card. The idea is simple: you transfer one or more of your existing credit card balances to the new card. Ideally, your balance transfer card will offer lower interest rates or other favourable terms, making it easier to pay off your debt.

Providers typically offer low interest rates for the first year, some as low as 0%. If you can pay the balance of the card in this time, you’ll effectively eliminate the interest charges on your credit card debt.

Be careful, though. If you miss a single payment deadline, your card issuer can revoke your promotional rate and hit you with penalties that include back-interest payments.

Bankruptcy

Bankruptcy may be a last resort for those with high credit card debt. If you’ve exhausted other options to repay your debt, you can declare bankruptcy. Most of your unsecured debts will be discharged, including your credit card debt. As such, you get a clean slate.

However, there are some major drawbacks to this approach. Your assets may be liquidated in order to pay your debt, and you’ll have to attend credit counselling sessions to develop better financial habits. Bankruptcy can also impact your credit score for up to seven years, making it hard to obtain credit cards and loans in the future.

Basically, taking out a line of credit can be a solid way to eliminate your credit card debt, but only if you do so responsibly. As with any major financial consideration, it’s crucial to think about whether a given solution has the potential to do more harm than good. If so, it may be best to find a different approach.

To help you achieve your goal of eliminating your credit card debt, here are the key steps you should take before opening a line of credit:

• Evaluate your financial situation to confirm you have strong credit and cash flow
• Calculate the potential savings
• Weigh the potential benefits against the potential risks
• Compare the interest rates of three different providers to find the best deal
• Investigate associated fees and penalties
• Consider alternatives to a line of credit

If you’re unsure how to proceed, it’s a good idea to seek professional advice. A qualified Credit Counsellor or financial advisor can guide your decision and help you make the right choice for your financial future.

If any of the options above sound like the right fit for you, or if you just need some advice regarding your debt, our certified Credit Counsellors are just a phone call away. Our debt counselling sessions are 100% free, confidential, and non-judgmental. Just call 1(800)267-2272 to book! You’ll get all the information you need to make the best decision for you and your financial future.