Debt consolidation firms, balance transfer credit card offers, cash out refinancing offers, and payday lenders all want to convince you of one thing: you can borrow your way out of debt.
The idea is simple: just extend your payment due date a few more years and you can lower your overall payments down enough that you can actually afford to live.
It’s a great idea on the surface. And there are times when it actually makes sense to do. But the truth at the core of the issue is this: you will never be able to borrow money to get out of debt. It’s not possible.
How Borrowing Your Way out of Debt Works
Here’s the pitch you will hear to entice you to take on more debt to pay off current debt.
You’re In Debt That You Can’t Afford
If you have reached the point of needing to go to a new creditor to borrow more money to pay off your current debts, you’re in a bad spot. You obviously can’t afford your current minimum payments nor afford to make any kind of dent in the balances of your debts. You’re chained to your current debt and unable to make any financial progress. You feel trapped. You need either more income or lower expenses. Instead of having to work more, why not just extend out your payments with some new debt?
You Borrow Money to Pay Off Your Debts
You go to one of a multitude of options to help consolidate your debts:
- a debt consolidation firm that gives you a loan
- a balance transfer credit card or two
- a cash out refinancing of your home
- a payday lender
- a friend that is crazy enough to let you borrow more money
Whatever method you choose you are able to get access to some new money that you will eventually pay off at some point in the future.
You Pay Off the New Debt
You take your newly acquired money and pay off all of your car loans, credit cards, and any other debt hanging over your head. Instead of having to make 7 different payments to 7 different creditors, you consolidate down to one payment each month.
The Truth About Borrowing Money to Pay Off Debts
Let’s contrast the sales pitch for debt consolidation to reality.
You’re In Debt You Can’t Afford
Yes, you are in debt you can’t afford. You have no one else to blame but yourself. You need to take ownership of your past spending decisions before you do anything. You need greater income, lower expenses, or both.
You Need to Have Behavioral Change
Instead of just lowering your expenses by extending out how long you have to pay off a debt, you truly need behavioral change. That means ending the cycle of spending more than you make. Remember, you got into debt by spending money that you didn’t currently have for whatever reason that seemed justifiable at the time. The only way to really get out of debt for good isn’t to take on additional debt – doesn’t that sound crazy? – but to put an end to that spending mentality.
You’re Pushing Out the Inevitable
Taking on a form of debt consolidation does work… for a time. You wipe out your minimum payments to all your creditors and are left with one giant bill to pay off. Yet without behavioral change you will inevitably find yourself right back where you started in a few months or years.
It can seem so freeing to pay off those debts, but if you don’t shred your credit cards you will probably end up continuing to use them. If you are using them – you’ve already shown you can’t handle that responsibility due to your current debt – you will likely end up spending more money than you have.
You’ll Probably Need to Borrow Again
When you repeat the cycle you will find yourself in quite the pickle. You’ve paid off debt with adding debt, and now you’ve added back the original debt through more bad choices in your spending.
You now have few options. No one is going to want to re-consolidate your loans when you are in over your head in debt again. This is where things get ugly: you have to cut back dramatically for several years to dig your way out of debt or face bankruptcy.
When Borrowing Your Way Out of Debt Works
I am really not a fan of taking on more debt to pay off debt. It’s like digging a hole to put the dirt in a hole you dug last year. You’re still left with a hole that needs filling in. It doesn’t matter how many shovels you have if you just plan to keep digging deeper.
However, debt consolidation can work in limited circumstances.
When You Make Drastic Life Change
First, you must make drastic life change. Taking on more debt to pay off your current debt is the last straw. You’re breaking the glass to grab the fire house.
That’s fine, if you stop playing with matches. You need to cut up your credit cards and vow to avoid debt. You need to work a spending plan, and try to increase your income and savings. Don’t keep doing the same thing you’ve always done and expect different results… that’s the definition of insanity. If you need to break the glass, do it, but make sure you change your life immediately.
When You Can Lower Your Interest Rates Dramatically
If you can take $20,000 of credit card debt sitting at a 18% interest rate and drop it to a significantly lower rate, you will obviously save money.
How much? Let’s compare rates:
- $20,000 at 18% with 2% minimum payment: $400 initial minimum payment, 54 years 6 months to payoff, $53,502 in interest paid
- $20,000 at 10% over 5 years: if you pay $421.43 each month you will pay off the loan in 5 years and pay $5,286 in interest
- $20,000 at 5% over 5 years: if you pay $375.86 each month you will pay off the loan in 5 years and pay just $2,552 in interest
In this example your payment doesn’t change much, but the amount of interest you pay and how long you are in debt is dramatically different. If you need lower payments you could take on a longer term like 7 or 10 years. Nonetheless you could save anywhere from $48,216 to $50,950 in interest. That’s serious money.
When You Work a Debt Payoff Plan
As part of your life change you still need to be working a debt payoff plan. You can’t just consolidate to a lower rate and go back to your old ways. Fight back against your bad habits by tracking your spending, setting up automatic payments to make sure you don’t get hit with a late fee (and a much higher interest rate as penalty), and cutting up the cards you have. Don’t take on any new debt until you’ve paid off the consolidation debt — and even then it is probably a bad idea.