Paying off Debt or Transferring it?

In one of those coincidental occurrences of nature, I have seen very similar things in many different places. It’s the concept of “paying off debt” by consolidating into something.

Picture by Dylan Gillis

Several different forms of this have come across my Facebook feed, email, and news articles in the past couple weeks, and I think it is worth discussing.

To start, I want to look at some common scenarios where I see this. One of the most well-known and most common is a debt consolidation loan. Basically, you take a loan large enough to cover your debts. The money from that loan is used to “pay off” your debts, leaving you with a single loan. This generally also comes with a lower interest rate because this method is often used to consolidate higher interest debts. To be clear, mathematically this is not a terrible idea. Lower interest means more of your money can go to paying off the principle. But personal finance is about more than math. The other very common method is basically the same principle, but instead of a personal loan, borrow against the equity in your home. This again has the advantage of reducing the number of different creditors you must pay and often brings a lower interest rate. However, it has the very significant disadvantage of increasing the amount of money you now owe on your house.

Although it is technically not the same, I’ll lump 0% balance transfers (common credit card tactic) into this discussion as well. This is not necessarily used to consolidate debt, but instead as a way for people to transfer one credit card balance to another card with a lower (commonly 0%, for a time at least) interest rate. Again, this mathematically makes sense, but in practice has a number of pitfalls that tend to snare people.

The reason calling these methods “paying off debt” bothers me so much is because you’re not actually paying off any debt. Debt is simply money owed to another person or institution. Not one of these methods decreases the amount of money you owe. They only change the person you owe the money to. In fact, they may increase the amount of money you owe because of fees, which are often rolled into the principle owed. It’s another example of feeling like you have accomplished something when you really haven’t. If you want to pay down your debt, decreasing the amount you owe is the accomplishment.

Personal loans to consolidate debt and balance transfers can be helpful in the process if they result in lower interest rates. However, your behavior change is what makes the real difference, not the interest paid. Just be aware that these methods are just tools, they’re not the solution. Rolling consumer debt like credit cards into your house payment, though, is something I can’t support even if it does decrease your interest rate. If you are truly unable to pay your credit cards, the credit card companies have little recourse. They can sue you, but if you have no money, there’s nothing for them to take. Once you borrow against your house to pay the cards off, you’ve transferred that debt to your house. Now, if you don’t make the payments, the bank can foreclose on your home. Transferring unsecured debt (credit cards) into secured debt (mortgage, home equity loan, car loan) increases your risk by exposing your possessions as collateral.

Helping people get out of debt and get their finances in order is my passion. I get excited just thinking about it. But I know it takes changes in the person, their behavior, and their habits to accomplish this. Don’t fall for the placebo that makes you feel better while accomplishing nothing. If you’re ready to rid your life of financial stress, I would love you help. *Schedule a consultation* today to start the journey.