Using a personal loan to pay off credit cards: the score math

Of all the ways to change your credit utilization, this one moves the number furthest in a single month. Lenders advertise it for exactly that reason. It also disappoints a lot of people. The utilization drop is real, but a new loan brings its own costs on the report, and one habit afterward can erase the whole gain.

Why the same debt scores differently as a loan

Credit utilization compares your revolving balances to your revolving limits. A personal loan isn’t revolving: you borrow a fixed amount and pay it down on a schedule. So when the loan pays off your cards, the cards report $0 and the debt now sits in an installment account that isn’t part of that ratio.

Installment debt still counts in the amounts-owed category, which myFICO weights at 30% of the score for the general population. It’s just measured differently. myFICO’s own example frames a car loan by how much of the original amount is still owed, and describes paying installment loans down as “a good sign that you’re able and willing to manage and repay debt.”

You haven’t paid off a dollar yet, though. You’ve only changed which bucket the debt sits in.

A worked example with the numbers

Example: three cards, all carrying balances.

Card utilization goes from 80% to 0%. Each card individually goes from 68% to 85% down to zero.

Now the cost side, using illustrative rates. Say the cards average 24% APR and the loan is 12% for 36 months.

• Loan payment: about $398.57 a month, for a total of about $14,349, so roughly $2,349 in interest.
• The same $12,000 at 24% paid off over the same 36 months would take about $470.79 a month, or roughly $4,949 in interest.

On these assumptions the loan saves about $2,600 in interest and gives you an end date. Many personal loans also charge an origination fee taken out of the proceeds, which means you may need to borrow a bit more than your card balances to fully pay them off. Check the APR, which includes required fees, not only the interest rate.

What the new loan costs you on the scoring side

The utilization drop isn’t free. myFICO lists what comes with it:

A hard inquiry for each application. People get burned here. myFICO says FICO Scores don’t deduplicate multiple hard inquiries for personal loans. The 14-to-45-day shopping window that protects mortgage and auto shoppers doesn’t cover personal loans. myFICO also notes that preapproval offers use a soft inquiry, which doesn’t affect FICO Scores, so compare prequalified offers first and formally apply only once.

A new account. myFICO says taking out a new loan “might initially hurt” your FICO Scores because it lowers your average account age.

A fresh balance near the original amount. A loan that’s barely paid down looks heavier than one that’s mostly paid. myFICO says the new loan’s high balance relative to the amount borrowed “might hurt your score,” and that it can help as it ages with on-time payments.

Credit mix, maybe. If you didn’t have an installment loan before, you’re adding one. If you’re already paying a car loan, the mix doesn’t change. Mix is a small factor; does credit mix matter explains how small.

Whether the utilization drop outweighs these depends on how high your utilization started. Going from 80% to 0% is a big change in a heavily weighted factor. Going from 15% to 0% is a much smaller change, and the new-account costs may cancel it out.

The mistake FICO Score 10 was built to catch

myFICO says FICO Score 10 was designed partly around the growing use of personal loans, “especially for purposes of debt consolidation.” Experian describes the practical effect: converting card debt to an installment loan “might help your credit scores,” but if you use the newly paid-off cards for new purchases, your FICO Score 10 “might take a hit.”

Lenders worry about one pattern in particular. The cards hit zero, the room feels like breathing space, and within a year the cards are partly full again with the loan still outstanding. Now you have more debt than you started with.

Trended-data scores make that pattern even more visible because they look at how your balances move over two years rather than one month. Trended data explains how FICO 10T and VantageScore 4.0 read the history.

Keep the cards open, but quiet

Closing the paid-off cards undoes part of the benefit. Their limits are the denominator that makes your utilization 0%. In the example, closing Cards A and B would cut your revolving limits from $15,000 to $4,000; any future balance on Card C would then count against a much smaller total. What closing a card does covers the rest.

For most people, the answer is to keep each card open with one small recurring charge on autopay in full, and keep the cards out of your wallet.

Loan vs. balance transfer

If you could pay the debt off within a year or so, a balance transfer may cost less. If you need three or more years, a loan’s fixed rate and end date are hard to beat.

Before you sign

1. List every card balance, limit and APR. Add up what payoff would cost you at your current payment.
2. Prequalify with several lenders using soft-pull checks. Compare APR, term and origination fee.
3. Apply formally with one lender.
4. Have the lender pay the cards directly if it offers that, or pay them yourself the day funds arrive.
5. Confirm each card reports $0 on its next statement. The utilization planner shows your before-and-after ratios.
6. Keep the cards open with a tiny autopay charge and don’t carry new balances on them.

A consolidation loan changes the shape of your debt, not the size. The score benefit lasts only as long as the cards stay near zero.