Loan

The Trouble with Taking Out a New Loan to Pay Debt

2 Mins read

When you’re struggling with debt, any option that promises a path out can seem tempting. Be careful about what you get yourself into, though. The wrong move can make your debt problems even worse than they already were. 

Credit Counselling Alternatives

Credit counselling can help you find out what the best move is before you act and provide alternatives to taking out a new loan.

How does credit counselling work? It starts with a certified Credit Counsellor from a non-profit credit counselling agency working with you to review your finances, manage a budget, and rebuild your credit. In addition to better money management techniques, there are also tools available to help you manage debt, such as a Debt Consolidation Program (DCP). Agencies like Credit Canada can help you with a DCP.

A Debt Consolidation Program provides you with relief and a simpler way to pay back your debts. It allows you to combine multiple unsecured debts into one lower monthly payment with reduced interest, or the interest is stopped altogether on any unsecured debts included in the program. The best part is you don’t need a good credit score to qualify for a Debt Consolidation Program, and you avoid putting secured assets (like home equity) at stake.

The certified Credit Counsellor will approach your creditors to work out a plan that will stop collection calls and give you relief on interest rates.

How New Debt Can Go Wrong

There are several ways you can use new credit to pay off old balances, and each comes with an important caveat.

#1 Home Equity Loans

You’ve owned your home for some time now, and you’ve managed to build up some equity in it. You decide to borrow against it to pay off a ballooning credit card balance. Because it’s secured, you qualify for a much lower interest rate and save money in the long run.

But what happens if you can’t pay back the home equity loan? Your home is collateral, and the bank can foreclose on you. You could lose your home and an important asset.

#2 Debt Consolidation Loan

A debt consolidation loan is an unsecured loan, so your assets aren’t at risk, but it comes with its own pitfalls. Primarily, you need a good credit score to qualify for one that will actually save you money.

There are other traps as well. If you use the money to pay off credit accounts but don’t close them, you could be giving yourself a chance to repeat bad financial habits. You could soon wind up owing twice as much.

#3 Credit Card Balance Transfer

Some of the same issues exist with a credit card balance transfer. With a balance transfer, you apply for a new credit card that will let you transfer all of your other credit card debts onto it. It can be a great move if the interest rate is lower. But if you’re not careful about using your newly paid-off credit cards, you can replicate the damage.

Many of these cards also offer a period in which you pay 0% APR, but it’s temporary. Unless you can pay off the amount in that period, you’ll be back at square one – at best. Think twice before you borrow more money to pay off pre-existing debts

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