Paying Debt with Debt – When You Should Do It
Well that sounds like a weird title, doesn’t it? How do you pay off debt with more debt? That just doesn’t even make sense. Having been writing on this blog and many other sites for some time, I have seen and written about a lot of things. My mantra is about fighting debt and growing wealth. While I talk about this often, I have been shown by some of my readers that I might not be covering everything that I should. While there are many people out there who are against debt at all costs, there are also many people out there who just need more information. They need to make an informed decision and I can’t fault them for that. I love making informed decisions. I got an email from a reader asking about how to deal with credit card debt. After going back and forth, we started talking about paying debt with debt. While I understand the concept, I don’t really like doing that. I am a “make more money” kind of person. That was the whole reason why I wanted to start Sprout Wealth. Teaching people how to make more money is an exciting subject. Who doesn’t want to make more money? Anyway, I wanted to provide some information about paying debt with debt for those readers who need it. If you don’t like debt, then keep that hatred burning. I am cool with that.
Paying Debt with Debt
This concept is not new. People have been doing this for quite some time. I did it when I played the balance transfer game with my credit cards. I would move credit card balances from one card to the next, while getting a lower interest rate. It was just exchanging debt for debt. People also do this with debt consolidation loans and personal loans. Paying debt with other debt has become common place these days. While I have done it before, there are some things to make sure you understand before you start moving debts around or asking for loans.
Paying Debt with Lower Interest Debt
Paying off debt with another debt really only works in a few scenarios. The most common scenario is when you can get a lower interest rate on the new debt compared to the old one. Interest rates are a killer. If you have a high interest credit card with a rate around 29%, then you might be better off looking for a personal loan with a rate around 16%. That is a big difference. You should only pay off debt with other debt when you can get a better rate. Well, there is one more common scenario as well.
Consolidating Debt for Ease of Management
Debt consolidation loans are common place. You see them touted on TV and in books. I have never done a legitimate debt consolidation loans, but that is because I have heard stories of companies doing this packages and then not paying the actual lenders. The customer would pay the debt consolidation company and they wouldn’t pay the lender. That is bad news bears for the customer.
Really, a debt consolidation loan is any loan where you are combining multiple debts into one. You can do this on your own if you want. You can get out a personal loan and then pay off multiple debts with it. This means you are only paying on the one personal loan, while the others have been paid off. This is a very common debt practice. You should really only think about them if you can get a good rate or at least one that is average of all your other debts. Don’t move lower interest debt onto a higher interest one just for the sake of consolidating. That is not a wise move.
Secured vs Unsecured Loans
Here is where things can get tricky. There are a lot of people who make the mistake of paying off unsecured loans with secured loans. This is a no-no! Let me describe the difference.
- Unsecured Loans – These are like credit cards. The loans are based on your ability to pay them back. Lenders go off of your credit score and your income. They base their decision on these factors and then set the terms for repayment. If you default on these loans and can’t pay them back, it is harder for lenders to retrieve their money.
- Secured Loans – These are loans given backed with collateral. Think of an auto loan or mortgage. When you get an auto loan, you are giving the ownership of the car to the lender. The loan you pay is backed by the car. If something happens, the lender will take ownership of the car and sell it to recoup their losses.
Never make the mistake of paying off unsecured debt with a secured debt. This happens a lot with a home equity loan or line of credit. Your home equity and in turn your home is your collateral. If something happens and you can’t pay back that line of credit, then you could lose your home. Don’t pay off credit cards with HELOC loans. That is a terrible idea. You are taking a loan which has no ties to personal or physical possessions and paying it with a loan that does. I would be waving my finger here if I could.
I don’t have any issues with people paying off debt with other debt, but I think there are only a few scenarios where it would make sense. Debt is debt and we can argue the good debt versus bad debt all day long. If you want to consolidate your debt or pay off high interest loans with other loans, make sure you are doing it for the right reason. Taking the time to research your loan options should be on your game plan. There are many places where you can learn more about loans and compare rates. You have to make the right decision for you and understand why you are making that choice.
What do you think about paying off debt with debt? Have you done it before?
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