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Does Borrowing to Pay Off Debt Make Sense?

Banking And Finance

Does Borrowing to Pay Off Debt Make Sense?

Yes, borrowing money to pay off borrowed money absolutely sounds counterproductive, until you take a closer look at what it entails. Generally referred to as debt consolidation, there are some significant benefits to be derived from doing this. So yes, borrowing to pay off debt does make sense — under the right circumstances.

What is Debt Consolidation?

Combining a number of debts (usually credit card obligations) into a single debt is known as debt consolidation. It can be accomplished by taking a personal loan in an amount sufficient to cover the balances being combined. Other methods include using a balance transfer credit card, or a home equity loan/line of credit.

The ultimate aims of consolidation are to reduce the number of bills you’ll have to pay each month, lower the amount of interest you’ll pay to close out all of those debts and shorten the time duration you’ll need to pay them all in full.

Let’s take a look at each of the methods outlined above.

Personal Loans are perhaps the least risky method of consolidating debt. You can get one without pledging any collateral — if your income, credit history and credit score warrant it. For borrowers with credit scores of 690 or better, interest rates capable of returning a better result for the borrower are usually attainable.

Which, by the way is the main caveat with personal loans for consolidating debt. You have to make sure the costs associated with the loan will be less than you’ll encounter if you just paid your debts off each in turn, which means you need really good credit to make this tactic work.

Balance Transfer Credit Cards, as the term implies, shift all of your outstanding credit card debt onto a new card at an exceptionally favorable interest rate — for a little while. Transfer card issuers will routinely offer zero percent or slightly higher interest rates on transferred balances for a period of 12 to 18 months.

Pay off the balance before that time period elapses and you’ll get a great deal. Let that window close however and you’ll encounter an extremely high interest rate of 25% or more. Further, some issuers will apply that rate to the entire transferred balance; regardless of how much or how little you have left to pay when the window closes. But wait, it gets even better, still others will also apply the new rate to the entire transferred balance, going all the way back to the date when the transfer occurred.

You’d best be careful to make sure you can pay off the entire amount you transfer in the time allotted if you go with this form of debt consolidation. Otherwise, this strategy could get exceptionally expensive — really fast.

Home Equity Loans/Lines of Credit are tied to the amount of equity you have in your home. This is the difference between the current market value of the property and the amount of your outstanding mortgage balance.

Lenders will offer you a percentage of that amount, in exchange for the right to force the sale of your home to recover their capital, should you prove unable to meet the terms of the loan agreement.

In other words, they’ll take your house if you can’t pay.

On the other hand, because these loans are secured by your home, the interest rates tend to be the lowest of the three options presented here. This can make them the least costly approach, even after all of the costs associated with getting a home loan are taken into consideration.

In Summary

Yes, borrowing to pay off debt does make sense — if you make sure you can live up to the terms of the deal you sign to get the loan.

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