Credit card out standings converted to personal loan

To reduce the interest rate burden converting credit card out standings to a personal loan is a good idea, but one should choose the right tenure carefully.

Banks fear that non-payment of dues will increase their non-performing assets, which would be bad for their balance sheets. Hence banks are offering to credit card users, who have overspent on their card, can convert their out standings into a personal loan. Such an offer also means that many customers, who have been facing difficulty in paying off the amount, can use this method to ensure that they do not become defaulters.

The biggest benefit on this kind of conversion is that the rate of interest will be much less on personal loans. As far as credit cards are concerned there is huge interest burden (between 36-44 per cent per annum) and is increasing with each passing month. Interest rate on personal loan is much less at 16-22 per cent, lesser by almost 40-50 per cent.

But, things are not that simple. There is an additional risk involved, even though when the interest burden slopes down, it can lead to a situation where it becomes very difficult for the consumer to manage his finances.

In case you go for a personal loan option regular monthly payments have to be made and for a specific time period. While this is good because it will mean a disciplined payout, for some, the situation can worsen.

This is may be because while the credit card company allows a minimum payment of 5 per cent per month, whereas in case of a personal loan the outgo could be higher, especially if one opts for a smaller tenure. For instance, if a person has an outstanding of Rs 2 lakh, at the rate of 5 per cent he will have to pay around Rs 10,000 monthly. If the amount is converted to a two-year personal loan at say 18 per cent, the outgo would be around Rs 18,000. Hence the sudden rise in the repayment amount by 40-50 per cent can lead to a situation where the budget goes completely haywire.

Thus in such situations, investments are the first one to be affected because other expenses are more difficult to control. And if this happens, the safety net that you are creating for the future could get reduced. In case you face such situation, it is important to select the right tenure so that the burden does not increase considerably.

Many times when you go for a personal loan, the bank might put a clause where prepayment is allowed only after a certain number of months or only so many times in a year. Moreover there can be even a hefty prepayment penalty if you were to exercise this option. This can be because the bank might be losing out on the interest income.

Individuals facing a temporary problem regarding payments should take a step back and give the situation some serious thought. If they get a cash flow, in terms of bonus or from any other source, they can use that to pay off the outstanding credit card bills. Yes, you will have to bear temporary pain because of high interest rates, but it would be a better option to clear the entire loan instead of giving out equated monthly installments (EMIs) for a long time.

The biggest risk involved in this is that the person can really go down further into a debt trap, if he continues to hold the payments and spend on the card. If you have chosen the option of converting the out standing on the credit card to a loan, there is no outstanding. This can easily lure a spendthrift to use it again.

This will again lead to rise in the balance on the card leading to financial crisis as the consumer will now have a personal loan and more credit card bills that need to be paid.