Plastic can definitely be a handy tool because of its versatility and can even be used to pay off a loan such as your mortgage balance or the remainder of your vehicle loan. People believe they are saving all kinds of cash when they pay off a loan with a rewards card or use a zero percent balance transfer with a new one. But as the old saying goes, “All that glitters is not gold” and rather than thinking you are getting one over on the financial powers that be, you could be setting yourself up for a gigantic financial disaster. Just keep reading to discover why.
The Pitfalls When You Pay Off a Loan With Credit Cards
Let’s begin with mortgages. First of all many banks will not allow you to even use a credit card to pay off the loan and if they do the way the card is processed, as well as the fees associated with the transaction, can be highly detrimental to you. For instance, banks have been known to use the cash advance option to pay off the loan which not only jacks your interest rate through the ceiling, but leaves you with some mighty big monthly balances to pay. Also, they really can charge any sort of amount for a transaction fee and that could add quite a bit to the original loan amount you were supposed to pay. That is certainly not worth the 1.5 percent cash back you receive from using your rewards card.
When it Comes to Auto and Student Loans
The scenario is not quite the same, but there can also be serious ramifications if you were to pay off a loan like this with your credit card. Both of these types of loans are secured, meaning the amount of interest you have to pay is locked in and is much lower than the majority of interest rates for credit cards. Even if you pay off your monthly balance religiously, these type of loans are normally for large amounts and if you can’t make the monthly payment in full you are actually paying more because of the additional interest from a credit card.
Many people think this strategy to pay off a loan is genius because even if the balance is large, they avoid paying any interest on it if they transfer the balance to a new card with zero percent interest. They have the best of intentions to pay this back in full before the no interest period expires, but the truth is many people are unable to do this. This leaves you with nearly triple the interest you had to pay on the original loan.
Also, using credit cards to pay off a loan can actually hurt your credit rating instead of boosting it. While you may have that large balance removed from your credit report, your credit lines are now nearly maxed which credit agencies view negatively.
Some Advice on How to Pay Off a Loan
In most cases, when people are thinking they should use their credit cards to pay off a loan or two or three, they are already not practicing sound fiscal policy or are short on funds. Instead of using your credit cards to pay off a loan, simply continue to pay the minimum amount due on all your accounts each month on time. You might think it will take you longer to rid yourself of debt, but it will keep your credit score intact and build the path to a more stable financial future.