Is it ok to pay off one loan with another loan?
Taking out one loan to pay off another should never be your first option. In this post we explore two ways you can borrow more, if there's no way around it.
Why you might pay off one loan with another
Say you get offered a new loan or new credit card with a sweet interest rate, one that's lower than the debt you've been carrying somewhere else. A 0% interest rate does seem pretty attractive in comparison to basically anything else.
If you're carrying a little or a lot of debt though, you should look at your finances to see if you're making the right decision. If you can afford to pay off your debt in a reasonable amount of time, you should be doing that before signing on for another loan or credit card. If you can reduce your expenses and spend less, earn a bit more here and there, and be strategic about your income then you can and will be on your way to a debt-free lifestyle.
Beware. If you're borrowing again just to fuel a lifestyle of spending that you really can't afford, you need to reevaluate your decisions. If you've found yourself without any savings, then you might be living outside of your means. Taking out another loan or credit card will only make things worse for you if you have bad spending habits.
Before taking out another loan or credit card, see if your present creditors will negotiate a new interest rate with you. That way, your debt won't rise as fast, allowing you to pay off your debt easier. If you need to borrow and there's no way around it, consider two options below.
Balance transfer card
This is when you take your debt from one place and put it onto a new credit card or loan, ideally with less interest than before. There will be an introductory period of 6 to 12 to 18 months where you will have 0% interest on your balance. The absence of interest is an excellent tool if you plan on repaying the debt.
But remember, the interest will return to that of a normal credit card as soon as this introductory period ends. If your loan isn't paid off by the time of expiry, it'll get nailed with high interest which will make your debt even higher if you haven't paid it off.
This option is recommended if you think you can pay your debt off easier without interest through decently sized payments each month. You need to apply for these cards before your debt gets out of hand or delinquent because they require good to excellent credit to obtain. In addition, there will be a transfer fee of a couple of percent, so it's important that you're sure you can pay it off or you'll end up with more, unaffordable debt.
Once you've paid down your total debt, it's important that you don't get in this predicament ever again if you can control it. Being debt-free will make you feel like you can spend again on credit. You have to, however, maintain your financial responsibility. It will be like you've just wasted all this time and money when you find yourself suddenly in debt again at a higher interest rate a few months down the road.
Debt consolidation loan
Similar to the balance transfer, a debt consolidation loan will put all of your debt onto a single lender, hence consolidation. They come in the form of a personal loan provided by either a bank, credit union or specialty lender. The payments you make on this consolidated loan will often be lower than the minimum payments you were making to all your previous lenders combined. Plus, you'll only be paying one bill.
The interest rate should be lower as well, to allow you to pay off all debts faster while saving the money you would be putting toward other, singular interest rates. Consolidation loans usually have higher balance limits because they're aware that you are putting multiple debts into one place.
Beware. Some consolidation lenders will charge you huge fees upfront so you need to shop around and find the most affordable option for yourself.
If you've been in debt for a long time, the consolidation loans might be difficult to qualify for, especially if you've fallen behind on other payments and your credit score has been damaged. Since your credit score explains some of the risks involved with lending to you, a low score will show some doubt to the lenders.
If they ask for forms of collateral such as your home or car (a secured loan) make sure that you can definitely afford to pay things off so you're not throwing away anything valuable if you fall into default.
The options above will make it easier to pay off your debt by putting all of it into one location. However, taking out one loan to pay off another one should never be your first option. See if you can first cut your spending, earn a bit more money, and be strategic with your income as it stands without adding more to your debt.
It's inadvisable to take out a loan against things you've already invested in, such as a 401k or life insurance policy.