No one wants to be overwhelmed by debt, yet thousands of people face this reality every year. They borrowed more than they could hope to pay. As the old saying goes, when you’re in a hole, it’s wise to stop digging. It is therefore sensible to avoid borrowing even a penny more when the situation becomes so difficult.
Is it really prudent advice?
In reality, an adage can not solve a question as complex as that of debt. Surely, increasing one’s liability by adding to the debt with new loans is not wise; the secret is to replace with good loans your existing bad loans.
Debt and the rehabilitation of your tax life
There is a caricature of the over-indebted people who imply that they spent irresponsibly, that they did not know how to live within their means and that they therefore deserve their fate. It’s true, there are people for whom it’s true, however most people are over-indebted due to circumstances out of their control: a job loss, a medical emergency requiring travel or even care a relative can all lead to a level of debt that exceeds the borrower’s ability to pay.
A responsible person looking to get rid of his debts usually stops borrowing the minute his financial situation or income improves. There is no harm in wanting to avoid increasing more debt. A restructuring or consolidation of what is due in these circumstances, however, can be a tool that allows a borrower to better manage the costs and payments associated with his debt.
Get out of the high interest debt trap
Financial difficulties can often come together. Someone who is in a precarious situation can easily miss a credit card payment or two, which often causes a salty increase in the interest rate on it. A reasonable rate of 11% can very quickly be 27% before the situation is stabilized. Render it, it can be even harder to reduce, let’s make pay the amount that is due on this account.
High-rate credit cards can trap a borrower in a nightmare scenario where he finds himself paying senseless sums with almost no progress towards deleveraging. Example: A $ 5,000 credit card balance with a 27% interest rate on which you make minimum payments of $ 130 per month will take more than seven and a half years to fall to $ 0! The total amount you would pay is $ 11,713, including the initial amount. That is, you would pay $ 6,713 in interest on just $ 5,000! Your first payment of $ 130 would only reduce the principal of $ 18, the difference being entirely an interest payment.
You can of course avoid this trap by making larger payments and decreasing the balance more quickly, but in an already precarious financial situation, this may be impossible. If you have three credit card accounts of this type and you make three payments of $ 130 out of a total of $ 15,000 of debt, you will find the time very long and the progress very difficult. These minimum payments would represent a significant financial obligation and an interest cost alone that would exceed $ 20,000.
In such a situation, it is clear that a loan with a more reasonable rate would be wise and responsible.
A new personal loan and a new reduced interest rate
If we continue with the above example and replace the same credit card from $ 5,000 to 27% with a personal loan of the same amount at 13%, the same payment of $ 130 would allow you to settle the account 40 months plus early and pay only $ 1,504 in interest – a total of $ 6,504 and a saving of $ 5,209!
When we look at the situation from this perspective, we realize that it makes sense to look for new loans when we face an overwhelming debt. It is not a question of borrowing to borrow but, funny, it is to borrow in order to save thousands of dollars and to deleverage more quickly! These are savings that you could reinvest in your future and in your financial life.
Consolidate your debts allows you to better manage them
When you owe large sums on multiple credit cards it can be difficult to manage your budget and payments as you need. The three payments of $ 130 in our example represent a total of $ 390, and this only to meet the obligation of the minimum payments! A single consolidation loan with a reduced interest rate would allow you to have one payment to be made per month with interest costs much lower than your current situation. In this scenario, it is easy to consider a new minimum payment of $ 280 – that is, $ 110 more available in your budget each month to pay for groceries, insurance, or any other bill. Or, if you want, you can also apply this amount to your new loan and get rid of it even faster!
A new loan can be a new start in your financial life
Far from us the suggestion that you borrow and borrow to fill every financial glitch. A loan can be a tool to improve your situation. It’s up to you to discuss it with a professional and see if this tool would be useful for you.