Debt is a difficult thing to understand for many people. It’s trickier to deal with when you have a lot of it. Some might consider the possibility of taking out more debt in order to pay back what they already owe. When does it make sense to borrow money to eliminate debt?
Interest Rates Are the Key Consideration
In any scenario involving debt, it’s essential to understand how interest rates come into play. Why is this? Because they can have an ever-greater effect on how much you’ll pay over the course of a loan than the actual amount you’re borrowing.
Don’t believe it?
Let’s look at payday loans as an example of this principle in action. Most payday loans are only for a few hundred dollars, as they’re typically taken out by people with lower incomes, and only meant to be held until their next paycheck, at which point the loan is supposed to be paid off.
Paydays are typically two weeks apart. According to the Consumer Finance Protection Bureau, the interest on the average payday loan works out to between $10 and $30 for every $100 borrowed. Assuming a payment of $15 for borrowing $100 for two weeks works out to an annual interest rate of close to 400 percent. For reference, that’s about 20 times higher than a typical credit card APR. This doesn’t even factor in the nightmare of fees you’ll face if you’re unable to pay off a payday loan.
Now that you see how significant of a role interest rates play in borrowing money, it’s time to dig into situations where taking on more debt might actually help you eliminate it.
It can be tempting to just increase your debt load in order to push your obligations farther into the future. But if you’re having trouble paying your loans, this isn’t a financially responsible decision, as much as it is delaying the inevitable. On the other hand, borrowing more money to eliminate debt can make sense when you’re able to meaningfully lower your effective interest rate.
If you have a $10,000 loan with a 10 percent interest rate, and you’re able to get another $10,000 loan with a 6 percent rate, it makes perfect sense to take that new loan and immediately pay off the old one, assuming the service fees don’t outweigh the interest reduction. Refinancing is another form of this, which is pretty typical, especially for home mortgages. If you borrow more money to pay off a debt, however, it’s essential you actually use that money on the original debt instead of being tempted to use it for pleasure.
Are You Going to (Realistically) Be Able to Repay This Debt?
Anytime you’re dealing with your personal finances, particularly regarding debt, it’s imperative you’re totally honest with yourself. We all want to believe things are going to work out for us. Yet, there were over 750,000 personal bankruptcy filings in 2018 alone.
Don’t fool yourself if you don’t think you’re going to be able to pay back your debt. The sooner you accept this, the sooner you can build a plan for getting yourself out of that hole. One option is a debt consolidation loan for bad credit. With debt consolidation, consumers can roll their various lines of credit into a single loan, which typically lowers the interest payment, and just generally simplifies the process. When done correctly, this is a way to get your finances back on track without having to declare bankruptcy.
How Strong Are Your Interpersonal Relationships?
If you’re able, borrowing money from a family member or friend can be an effective way of getting out of debt. Oftentimes, the people closest to you will be more sympathetic to your situation than a lender, who generally just sees you as a factor in their bottom line. Relatives or friends might be willing to lend you money at a lower rate than institutions, which can help you break free from the interest cycle.
It’s important to note, however, there can be some unintended consequences from doing this. You really need to pay back money that you borrow from friends and family. First of all, it’s going to negatively impact your relationship if you don’t do that. But furthermore, they don’t have massive cash reserves like banks. Not paying them back could be dire for their own finances.
Generally speaking, borrowing more money isn’t going to get you out of debt. But there are a few situations where it can make sense to take on more debt in order to get your fiscal life back on track.