Financial Answer Center

When people think of paying off their debts, the first thing that comes to mind is getting a large debt consolidation loan and paying everything off with that. The problem is, you're still left with DEBT. The remainder of this guide will focus on ways to borrow, but you should first ask yourself is there another way?

You need to keep enough cash for three to six months of emergency money, but if by chance there's more, think about using that.

Are there assets you can use? You may have some savings bonds, or some stock options, or an inheritance. However, think carefully before you use long-term assets to pay debt. You may need this money in retirement.

Are you making payments on things you don't really need? Do you have to have a $30,000 car when a $15,000 one will get you to the same places? Do you need that fancy stereo? Consider selling the things that aren't really necessary.

Could you take a second job temporarily, and use the money from that to make extra payments on your debt? Can your spouse or your older children take a temporary job?

Types of Loans

If you do decide to borrow, below we list a number of different kinds of loans and the risks associated with them. You can't borrow money without risk. All of these types of loans can be used for the purpose of consolidating your debts.

SUGGESTION: There is a Catch-22 that many people face when looking to dig out of debt: the more you owe, the tougher it is to borrow, and the higher the interest rate you pay. Your goals should be: 1) to MINIMIZE the interest you are paying, net of tax, and 2) to pay down the debt as quickly as possible.

Source: If you have equity in your home, that's a logical place to look for funds. The interest rates are usually reasonable on home equity loans and lines of credit. Risk: If you can't pay the loan back, you risk losing your home.

Source: Refinance your first mortgage if current market rates are lower than your existing mortgage rate. The interest is tax-deductible. Risk: If you default on your mortgage, you risk losing your home. Also, consider the costs of refinancing when evaluating this option.

Source: Your company retirement plan. You are borrowing from yourself, and usually paying yourself back at the prime rate, or close to it. Risk: You limit your return to approximately the prime rate, and if much of your retirement plan money is in equities, and they are performing well, you may be giving up quite a bit of gain. There is also the risk of not paying the loan back, being subject to withdrawal penalties, and jeopardizing your retirement.

Source: Permanent life insurance. The interest rate varies depending on the company, as do the fees. How much you can get depends on the cash value in your policy. Risk: If not repaid, death benefits will be reduced.

Source: Personal loan. May be secured or unsecured. Interest rates tend to be high. Risk: Getting further behind the 8-ball with high payments.

Source: Credit cards. Risk: Interest rates generally up to 24%.

Source: Family and friends. The IRS may require you to impute interest at a rate set by the U.S. Treasury (the applicable federal rate). Risk: Putting severe strains on the relationship. Make sure that the loan is documented in writing and includes the specifics of the loan arrangement, such as the date of the loan, the parties involved, the date by which the loan is to be repaid, the number of payments, the interest rate (if applicable), etc. If the loan is for a large amount, consider having a lawyer draft a legally binding document.

Interest Rate Example

To show you the difference interest rates can make, let's look at two $10,000 loans:

SUGGESTION: Treat your debt like a term loan, even if it is open ended. If you have to pay off $20,000 in total, for example, you could pay it off over five years by paying $425 per month at 10% interest. You could pay it off over ten years by paying $264 per month at 10%. The higher the interest rate and the shorter the term, the larger the payment.