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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, 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.

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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. 

Educating yourself on personal finance and understanding the financial products that you use everyday can make the difference between comfortable finances and constant stress. At MyWalletHero, we aim to make learning about personal finance rewarding and fun.

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