Posted by Mike Smith :: April 26, 2008 @ 11:15 amIt may seem surprising, but taking on more debt is often the best way to reduce overall debt. This only works if those who borrow money use their new debt appropriately and take steps to deal with the root causes of their money problems.
Debt consolidation starts out by adding to an ailing consumer’s debt. While people may consolidate in order to reduce their debt, their first step is to take on more debt. People looking to consolidate all of their credit card debt will actually double their debt by taking out a consolidation loan. That’s why it’s so important to use the proceeds of the new loan completely as intended and as quickly as possible.
Let’s say that you had $15,000 in debt spread across 3 credit cards. To consolidate all of that debt, you could take out a loan for $15,000 with a lower interest rate than what the credit cards are charging. Until you actually use the loan proceeds to pay down your credit card debt, your total debt would increase to $30,000. Of course, as soon as you use the $15,000 loan to pay off your credit cards, your debt would be back to $15,000. The reason you would do all of this to end up in the same place that you started ($15,000 in debt) is that, with an interest rate much lower than what you had been paying on your credit cards, your new lower monthly payment will allow you to get out of debt much more quickly.
The danger of using debt consolidation to remedy personal finance troubles is that after you pay off your credit cards, you’ll have $15,000 in low interest debt, plus at least $15,000 in credit available on your credit cards. So not only do you need to use your personal loan to pay off your credit card debt, but you also need to avoid using the credit available on your cards.
Borrowing money at a low interest rate to pay off debt at higher rates can save you money, but this must be done with care. Continuing the habits that caused the original debt will cause your overall debt to grow.
Leave a Reply