Does it make sense to borrow money to help solve a problem caused by borrowing money in the first place? In some cases, yes.
Credit Card Consolidation and HELOCs
The obvious case is when you can shift debt from a high interest loan, such as a credit card, to another type of loan with lower interest rates, such as a credit card that has a lower rate or a home equity loan (HELOC).
For example, let’s say you are carrying a balance on one or more credit cards with interest rates that vary between 14% and 25%. If you can find a card that carries a lower interest rate, you could move your existing balances to this lower interest card. You could then use what you save on interest to increase your monthly payments.
Credit Card Consolidation with a Peer to Peer Loan.
A HELOC line of credit has similar advantages to credit card consolidation and then some. First, you can use the loan proceeds on a 6 to 7% loan to pay off higher interest rate credit cards. Second, HELOC interest is tax deductible on an itemized tax return. The downside to a HELOC is that you are risking your property.
Be aware that transferring debt (such as credit card balances) to another credit card with lower interest or opening up a HELOC line of credit will involve one-time upfront fees. Be sure to factor in those one-time upfront fees (minus any tax deductions on a HELOC) along with the interest rates to see if it makes sense to borrow money to reduce existing debt.
But what if you can’t find a lower interest credit card or you don’t own a house or you own one but you haven’t built up enough equity to open a HELOC line of credit?
Personal Loans & Peer-to-Peer Lending
In this case, friends or family might be willing to give you a loan at a low (or no) interest rate. The risk here, of course, is not treating this type of loan as a “real” loan and either being late or skipping payments. If you do that, you could suddenly find yourself forgotten about when it comes to birthdays, holiday invites or family reunions. At worse, you could find yourself squared off against a family member or friend in civil court.
When you can’t find a credit card with a low enough interest rate or you don’t own a home and you don’t want to risk your family and personal relationships with a personal loan, an often overlook alternative is what’s called peer-to-peer lending.
Peer-to-peer is a type of financial transaction that directly connects borrowers and lenders by eliminating the costs of an intermediary (e.g., a bank). Peer-to-peer lending offers significantly lower interest rates than the average credit card company and it often has lower one-time upfront fees.
Note. You should not be borrowing money to reduce debt if you answer yes to one or more the following questions:
1. Do you consistently go over your credit card credit limits?
2. Are you often late with payments?
3. Are you currently in default on a loan?
4. Do you feel your spending is out of control?
If you answered yes to one or more of these questions, you need to find a competent credit counselor to help you reduce your debt in other ways.