Is paying off debt by borrowing additional money a good idea?

Years ago, paying off your debt with more debt might not have been considered a good financial move. In fact, …

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Years ago, paying off your debt with more debt might not have been considered a good financial move. In fact, it might have been considered a little reckless. Modern credit products, however, offer consumers options that may just ease up the debt burden a bit.

Thanks to growing consumer demand, things are starting to change as financial institutions are forced to be more competitive. The result? A pleasant mix of credit products that have the ability to free up your cash flow.

There is a snag, however: discipline is essential to make them work. These products can only be truly effective if used for the purpose of minimising financial commitments, easing up cash flow, or reducing the cost of credit.

Personal loans can be cost effective

Personal loans are known for their ability to free up cash flow. While there are some credit cards that offer lower interest rates, personal loans are generally a cost-effective option for those looking to consolidate their debt. 

A personal loan for consolidation purposes allows consumers to streamline their finances by potentially paying smaller monthly instalments. These loans are for those who have multiple smaller loans at high interest rates that may be causing cash flow problems.

The consolidation means consumers only have a single instalment to worry about each month. It also allows them to begin actively reducing their debt as a personal loan is usually provided on a non-revolving basis, meaning the instalments all go towards reducing the balance. The instalments are fixed for the duration of the loan and any additional borrowing would require a new loan application. 

In order for the consolidation to make sense, it’s wise to make sure that the interest rate and fees for the consolidation loan are lower than what you’re currently paying on any existing loans.

It’s also a good idea to consider the length of the loan period remaining on your existing loans. If you merge a high-interest loan with only a few monthly payments remaining into a low-rate personal loan that has a longer term, you might actually end up paying more overall. You would then need to decide whether the simplified cash flow is worth the potentially higher total repayment. 

Credit cards for the win

The 0% balance transfer card is a game-changer for those looking to reduce their debt and interest costs. This type of credit card allows you to transfer balances from other cards with high interest rates to one manageable location. They typically offer an interest-free period of between 4 and 36 months, depending on your circumstances, giving you a chance to kick-start the clearance of your debt. Some of these cards also offer consumers 0% interest on spending for a period of time.

This option is perfect for those who are stuck with credit cards that carry high interest rates, and wish to simplify their repayments. The caveat is that the 0% interest rate is really only effective if you manage to pay off all or a sizeable portion of the debt before the card’s interest rate kicks in.

It’s also worth noting that these cards may have a transfer fee, which is usually a percentage of the debt. It’s important to compare the cost of transferring the debt to the savings achieved by the 0% rate to determine whether it’s worth the move.

Accessing equity in your property

Home equity is the difference between the value of your property and the outstanding balance of your mortgage. For example, if your property is valued at £200,000 and your outstanding mortgage is £130,000, then the equity is £70,000. This amount can be accessed through remortgaging or a home equity loan.

Remortgaging is the same as a mortgage; however, you may be in a position to negotiate a shorter term for the remortgage portion of the loan, and there might be a difference in the interest charged on this portion of the loan. A home equity loan, however, is a secured loan where the equity in the property serves as security, much like a personal loan but with the added layer of financial security for the bank, which is your property.

These types of loans are handy for big purchases or finance requirements such as home renovations or consolidating debt. The benefits of accessing these loans include the option of longer repayment terms and relatively low interest rates.

A word of caution, however, is that making repayments over a longer term may end up being more expensive in the long run. It’s also important to be aware that your property is the security for both loan types, which means that defaulting on the repayments could put your property at risk.

Takeaway

Additional borrowing can help to make managing and paying off your debt more comfortable. However, while taking on further debt can improve cash flow and streamline finances, it’s important to go with the option that makes the most financial sense and best suits your personal circumstances. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

MyWalletHero, Fool and The Motley Fool are all trading names of The Motley Fool Ltd. The Motley Fool Ltd is an appointed representative of Richdale Brokers & Financial Services Ltd who are authorised and regulated by the FCA, and we are permitted in this capacity to act as a credit-broker, not a lender, for consumer credit products (our FRN is 422737). The Motley Fool Ltd does not have permissions for, and does not advise on, investment products and services, but may provide information on investment products and services.

The Motley Fool receives compensation from some advertisers who provide products and services that may be covered by our editorial team. It’s one way we make money. But know that our editorial integrity and transparency matters most and our ratings aren’t influenced by compensation. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. The Motley Fool has recommended shares in Lloyds, Tesco and Barclays.

More on Personal Finance

Note paper with question mark on orange background
Personal Finance

Should you invest your ISA in a model portfolio?

Which model ISA portfolios offer both high performance and low fees? Hargreaves Lansdown, Interactive Investor and AJ Bell go under…

Read more »

Economic Uncertainty Ahead Sign With Stormy Background
Personal Finance

Is it time to exit emerging markets investments?

Investors may well be sitting on losses from emerging markets funds. Is it worth keeping the faith for a sustained…

Read more »

Personal Finance

Share trading? Three shares with turnaround potential

Share trading has been difficult in 2022, but which companies have turnaround potential? Jo Groves takes a closer look at…

Read more »

Man using credit card and smartphone for purchasing goods online.
Personal Finance

Revealed! Why Gen Z may be the savviest generation when it comes to credit cards

New research reveals that Gen Z may be the most astute when it comes to credit cards. But why? And…

Read more »

Environmental technology concept.
Personal Finance

The 10 best-performing sectors for ISA investors

The best-performing sectors over the past year invested in real assets such as infrastructure, but is this trend set to…

Read more »

Road sign warning of a risk ahead
Personal Finance

Recession risk ‘on the rise’: is it time for investors to worry?

A major global bank has suggested the risk of a recession in the UK is 'on the rise'. So, should…

Read more »

pensive bearded business man sitting on chair looking out of the window
Personal Finance

1 in 4 cutting back on investments amid cost of living crisis

New research shows one in four investors have cut back on their investing contributions to cope with the rising cost…

Read more »

Image of person checking their shares portfolio on mobile phone and computer
Personal Finance

The 10 most popular stocks among UK investors so far this year

As the new tax year kicks off, here's a look at some of the most popular stocks among UK investors…

Read more »