Borrowing to pay off debt: a good idea or not?
Summary
Borrowing to pay off debt: a good idea or not?
- Borrowing to clear your debts is only a good option if the conditions of the loan are better than those of your debts. If they aren’t, you could end up further in debt.
- Avoid asking your friends and family to lend you money. There’s no price on your relationships and you don’t want to break the trust of the people you care about. There are other options.
- Before filing for bankruptcy, consolidating your debts might be a good way of freeing yourself from creditors. The bank will be the one paying them. Then you just have to pay back the bank after that. Also, if you respect the payment terms, there shouldn’t appear any mention of it in your credit file.
- Keep in mind that 15% of your credit rating is based on your credit history. When you close accounts (credit cards, personal loans, etc.), it has a negative impact on your credit score. If your goal is to improve your credit rating, once your credit card is paid off, keep the account open.
The right conditions for borrowing
Of course it can be tempting to borrow money to clear debts you’ve been accumulating for a long time. It’s especially tempting when creditors start to get more aggressive and intimidating.
The best thing to do in this case is to keep a cool head. When looking at the loan options to repay a debt, it’s important to look closely at the payment terms: the interest rate, the payment periods, and the payment amounts.
Simply put, your loan’s payment terms should be better than the current payment terms of your debts. Why? Because your new loan should allow you to save money, not lose more.
4 times when borrowing is a bad idea
- Your debts are too big.
- The interest rate on your loan is bigger than the interest rate on your debts.
- Someone has to be your guarantor.
- The collateral required for the loan is too high.
If you find yourself in one of the following situations, you might want to look into other options. These include filing for a consumer proposal or bankruptcy. You could also consolidate your debts. By making an appointment with one of our advisors, you can get a clearer idea of your options.
Debt consolidation: the loan you may need
What is debt consolidation? It’s a loan from your bank to pay back all your debts at once. The bank essentially pays all your creditors on your behalf. You just need to pay back the bank as per the contract you sign with it.
What’s practical about debt consolidation is that you only have one payment to make each month. Also, the interest rate is often lower than that of your creditors. Another advantage: If you make your payments on time, your debt consolidation won’t have any negative impact on your credit score. By proving you are a good payer, your score will actually improve.
That said, it’s possible that your bank may not grant you this loan. Banks are generally only interested in offering debt consolidation to people with sound financial health. If you’ve had difficulty making payments on time in the past, you may need to explore other options.
The risks of borrowing money from friends and family
Your friends and family are of course there to give you support. But before asking them for money or letting them lend it to you, always look at the pros and cons.
First you should ask yourself: Will I really be able to pay them back? If the answer is no, borrowing from them could affect these relationships. It’s not easy to be deep in debt. But it’s definitely not a good time to complicate your relationships with the people you care about.
You also need to ask yourself: Will the amount of money they would lend me will really make a long-term difference? Will it fix my debt problems? If not, this is likely a sign that your issues with debt are serious enough that you should consult an expert.
Be careful of instant loans
You need to beware of any loans that claim to be “easy” to repay and that don’t require a credit check. They often have extremely high fees and interest rates (frequently 29% or more), which can easily lead to more debt, even from small loans.
Never forget that there’s no such thing as “easy money.” When an offer that’s too good to be true comes along, it’s important to see if for what it is.
