Debt

Paying Debt with Debt – When You Should Do It

Pay off debt with debtWell 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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Grayson Bell

Grayson Bell

I'm a business owner, blogger, father, and husband. I used credit cards too much and found myself in over $50,000 in debt. I paid it off, started this blog, and my financial life has changed. I now talk about fighting debt and growing wealth here. I run a Wordpress management company, along with another blog. It is Empowered Shopper, which helps people get information about products they want to buy.

28 Comments

  1. May 23, 2014 at 6:32 am — Reply

    It’s a good idea to lower the interest and I completely agree with your verdict that secured loans are a “no-no”!

    The other more insidious problem I think occurs when people get so caught-up in trying to refinance their debt that they lose focus on the aim of CLEARING it, not just reshuffling it. 0% balance transfers – why would you pay off anything except the minimum? The answer is that times may get harder later on, then you will be glad that you have less debt. If you have a mortgage at a low rate at the moment, this is a golden opportunity to pay off your debts and it isn’t going to last forever!

    • June 2, 2014 at 12:29 pm — Reply

      Great point Sara and I completely agree with you. When doing this, you need to have a clear path to paying off all debts. You can’t pay off one and then start using it again.

  2. May 23, 2014 at 7:56 am — Reply

    I know someone paying debt with debt, one of my relatives asked me if I could lend him money because he would pay his debt. But I refused him, for me, it’s not a good idea, he should find a way on how to pay his debt to his friend not to make a debt again to another person.

  3. May 23, 2014 at 8:22 am — Reply

    Like you, I think it should generally only be done is specific circumstances. I played the balance transfer game when I was in debt and it made sense then. If you can significantly reduce your interest rate then it makes sense, beyond that not so much.

    • June 7, 2014 at 10:01 am — Reply

      The balance transfer game was my game of choice.

  4. May 23, 2014 at 8:59 am — Reply

    I totally agree with you, focus on eliminating the debt and only use other debt if it helps you to achieve that end in a clear way!

  5. May 23, 2014 at 9:34 am — Reply

    If you can get a better interest rate on your debt it seems like a no brainer.

  6. May 23, 2014 at 9:36 am — Reply

    I’m not a fan of the idea of paying debt with other debt, unless you can get a significant break on the interest rate. Even then, I think that people who still have a “spend” mentality are likely to get themselves back in trouble by charging more on the now-paid-off credit card. I think it’s a slippery slope here and you have to be really careful.

    • June 7, 2014 at 10:10 am — Reply

      You have to deal with why you got into debt before you should think about this process.

  7. May 23, 2014 at 2:53 pm — Reply

    Barclay Card has a little known free rewards card that I signed up for a few years ago. 0% interest for 12 months so I used it to buy a laptop that I paid off before the 12 months were up. Because Barclay, a British bank, is desperate to be a big hitter in the American credit card market, they have great deals on the cards they offer us in the States. My previous 0% interest card started sending me 0% interest balance transfers with only a 1% fee for 14 months! And you could use it to write yourself a check and it wasn’t considered a cash advance, so of course I deposited the check! I used that money to pay off my highest interest student loan debt and will have it paid off before the interest clock checks in. I would have paid the high interest loan off in the same time frame without the balance transfer, but this saved me tons of interest, even with the measly 1% fee. (note, the loan was $13,000 at 6.55%)

    • June 7, 2014 at 10:11 am — Reply

      I have done something like this before, but I don’t really do it much anymore.

  8. May 23, 2014 at 5:53 pm — Reply

    I totally agree. Use debt to pay debt wisely. Get a lower rate and make sure you pay within the timeframe. (Most balance transfer offers are good for 12-18 months.)

  9. May 23, 2014 at 6:40 pm — Reply

    I completely agree with your reasoning here, Grayson, and I like how you’re always looking for new ways to help people get debt free. Great post!

    • June 7, 2014 at 10:12 am — Reply

      Thank you Laurie. I realize there are many different reasons why people are in debt, so I want to give different ways to get out.

  10. May 24, 2014 at 12:09 pm — Reply

    I’m currently using this strategy to pay off my debt. I transferred it to a 0% interest credit card for 18 months and I’m working on paying it off before the offer is up. You have to do this strategically so that it can work to you’re advantage otherwise you will just be stuck in a bad cycle. I know people who have been overspending for years and just rolling the credit card debt into their home by refinancing every few years. That is just craziness and not very wise as you stated above.

    • June 7, 2014 at 10:13 am — Reply

      Good for you Raquel. It is a viable way to do it if you are smart and know why you got into debt in the first place.

  11. May 26, 2014 at 2:18 pm — Reply

    It makes sense to use lower interest debt to pay off high interest debt, but I would be careful transferring unsecured debt to secured. While it may lower a debt’s interest rate, it puts you in danger of losing the item used to secure the loan. Do you really want to take a chance on losing your home just to lower your credit card payments?

    Of course the final goal should be to get out of debt completely.

    • May 27, 2014 at 6:47 pm — Reply

      I agree and that is why I indicated that you shouldn’t do this with secured debt. You should never move unsecured debt to a secured one. That is a recipe for disaster.

      • May 27, 2014 at 7:14 pm — Reply

        Somehow I went dyslexic and thought I read that a person should use a lower-interest secured loan to pay off a higher interest unsecured loan. Now that I read more carefully, I see that you were saying exactly what I did. Sorry.

        • May 27, 2014 at 10:01 pm — Reply

          It happens to the best of us Bryce. I would never recommend anyone using a secured loan to pay off an unsecured loan. Only unsecured paying off unsecured.

  12. John Carter
    May 29, 2014 at 1:29 am — Reply

    Most of my friends used to pay their debt by taking new debt for paying the old debt, but only some of them able to use it effectively. Paying debt with debt is not everyone cup of tea as there are high risks involved if not used with good strategy.

    • June 7, 2014 at 10:13 am — Reply

      This is not everyone’s cup of tea for sure. You need to understand why you had debt in the first place.

  13. June 10, 2014 at 8:23 pm — Reply

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  14. July 18, 2014 at 8:20 pm — Reply

    I did this initially when I tried to get out of debt and failed miserably. But, it was more because I never got to the root issue of my debt. Once I figured everything out, I did carry debt for a bit. I had a small balance on a 0% card and would take my time paying it off. I would usually get a 0% transfer offer from one of my other cards and transfer it over to continue the 0%. I realize I was paying a transfer fee, but it was only 2% and was worth it to me to do that and invest the excess money I had laying around because I could earn more there.

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