Stupid or Smart? (Getting a Loan to Pay Off Your Debt)
Should you get a loan to pay off debt?
In most cases, no. Just because you can get a loan to pay off your debt, doesn’t mean you should. After all, are you really “paying it off” by using another loan?
What you’re doing is delaying the inevitable and/or making the debt a bit less painful to bear (either because you lower the interest rate, payment, or lengthen the time you have to pay it off).
But I know there are circumstances where life happens and backs you into a corner, debt-wise. Whether it’s a job loss, or unexpected medical costs, life can send you in a tail spin and leave you with excessive credit card debt. Most of us have been there.
At this point you can choose to do a couple of different things. First, you need to make sure you stop the bleeding. Find a way to get more income, and/or drastically reduce your expenses to live within the means that you do have. If you don’t do those things then you’ll be right back here in a few months or years looking for another loan to help you get rid of credit card debt.
Next, you can try and tackle this debt yourself by negotiating interest rates with credit cards, developing a debt reduction plan, and basically taking this debt on head first. Remember, there is no Obama credit card debt relief. Finally, like I said above, you can use a loan to help you delay or extend the debt pay off process. Here are some loans you could use.
Different Loans to Pay Off Debt
Home Equity Loan – If you own a home and have some equity (your home is worth more than you owe on it), you could tap into that home equity and get a loan for the amount of your debt. Doing so will likely take a high-interest debt and reduce it to a lower interest rate. However, you are taking an unsecured debt and turning it into a secured debt. You are putting your home at risk because of some retail spending. Not a good move.
Peer to Peer Loan – Take the banks out of the equation. Borrow some money from on online lending service. Peer to peer lending is growing in popularity because of the lack of credit elsewhere, and because it makes sense for some people. If you use this type of loan, you’ll likely pay less interest over time, and you can extend your monthly payments to a more manageable level. Read more about the option of peer to peer lending.
Personal Loan – Some banks or credit unions will give you a personal loan if they can see consistent deposits in your checking account and a steady paycheck. These loans aren’t secured so there is no asset at risk except your checking account. You can likely reduce the amount of interest on your debts significantly by using a personal loan. Compare personal loan offers from top providers by checking out Fiona.
Life Insurance Loan – If you have a life insurance policy with a cash value portion, you can take a loan against those funds to help you pay for the debt. I’m not a fan of this option since it goes against the original goal of the money, to protect your spouse and children.
Debt Consolidation Loan – Take all your debt and put it on one payment plan. You have to be careful with these loans because the company who if performing the consolidation for you is in business to make money off of you. In most cases with a debt consolidation, you will pay more interest over the long term and it will take you much longer to pay off the debt. Finally, people who consolidate debts this way often find themselves in dangerous levels of debt again. In other words, they don’t address the root cause.
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401K Loan – Similar to a life insurance loan, the 401K loan borrows money from a source where the original intent is something other than consolidating debt. For this reason, I’m not a fan of using a 401K loan to help you pay off debt. But these loans are pretty easy to make. Your 401K administrator isn’t concerned with what you use the money for. They will just loan you the money. And when you pay back the money, the minimal interest rate is actually paid to your 401K balance.
Balance Transfer – If you can get accepted, you might be able to get a 0% balance transfer credit card. You could do your own consolidation by taking all your outstanding balances and transferring the debt to one single credit card. In most cases, the new credit card will have a promotional 0% interest rate period and a 3% to 5% fee to make the transfer. I’ve made this move with success in the past, but it’s getting harder and harder to perform this move nowadays.
Have you ever taken out a loan to “pay off” debt? Were you better off after making the move?
Hi PT – good post!
I’ve never been a fan of taking on more debt to pay of debt, regardless of the circumstances. I learned this the hard way when I was in college. I paid for school with credit cards and the debt seemed to follow me year after year. Never again will I borrow to pay off debts. Surprisingly, many people make this mistake. Call it lack of financial education or just plain lack of reason, taking on more debt to pay off debt should never be considered as an option in my view. Instead, (as you mentioned) people should look for alternative sources of income. Technology and the internet have made this a possibility for almost everyone. All it takes is a very strong will and persistence. What do you think about using the internet to build an alternative source of income to pay of debt rather than borrowing more?
@Moneyedup – good point. a benefit to consolidation is that the loans are consolidated. i agree. easier to zero in on the debt.
When you have two separate loans, it can be a good idea to take out money from one loan to pay off the other so that you are just focusing on paying off one lump sum instead of two separate ones. To me, it just makes things easier. You have to be careful to examine your interest rates before doing this though.
Not only is borrowing to pay off debt ignoring the real problem, but it can very easily make the problem worse. I’m all for lowering interest rates, and if a loan or balance transfer can do that, great, you’ll pay off your debt faster (and pay less interest). But if you haven’t fixed the real problem (too little income or too much spending or both), then you’ll be tempted to use the credit on the card or loan that was paid off!
i have not done this, thank goodness. i have seen friends take out HELOC and regret it after they have done it.
it almost seems the best thing to do is either get a new job, get a second job, sell some belongings, or borrow from a family member. if do get another loan it could really end up setting you back even further.
Funny – I was just thinking about this today. Yes, we did take out a loan to pay off credit card debt some years ago. It was such a false sense of accomplishment because we felt that we had eliminated the credit card debt , but had the additional loan payment to make every month in addition to our mortgage payment. And because that extra loan payment tied up our monthly income, guess what…….yup, more credit card debt. We are only about 5 years away from paying off the mortgage and do not want to incur any more debts. If we decide to tap into the equity of our home, it would probably be only for major home improvements, such as updating our bathroom and replacing a very large picture window.
Thanks for a great post!
@PT – Yup, in a little over a year. I made a good case for convincing him to lend me the money. I had already gotten in (200 students applied, 25 got in) and I was his 20 year old daughter who had never asked for money (minus the typical 10 year old question, what do you mean I can’t have a pony?)
@Jenna – Oh, good one. The friends and family loan program. Were you able to pay it off completely?
The only time I’ve borrowed money to pay off debt was from my dad. I got into a program at my university which cost me $2,000 more than I had budgeted for. My dad offered to loan me the money at zero percent interest. But I’m not sure if that is the kind of example you were thinking of.