Taking out a loan to pay off your debts makes as much sense as finding yourself in a deep hole and asking someone to throw down a bigger shovel. For many people this is the most appealing and most destructive course of action. But for a select group of the population taking out a debt loan can turn out to be a very wise strategy.
Most of the people I’ve met who are constantly up against the debt beast have tried the borrow until I’m out of debt strategy only to find themselves deeper in debt every time. Why does this not work for them? On the surface it made some sense. Take all your debts such as credit cards, department store cards and outstanding loans and role them all into one loan with a smaller monthly payment. For a moment and it is an extremely brief moment they can breath financially again and they even have a little cash flow happening in their lives. What do they do with the extra cash flow? They spend it. And typically on stuff that they don’t need, has no resale value or can’t afford. Now they are back to scraping by between paychecks, only with a debt load that has been stretched for a longer period of time resulting in a much higher payout for their creditors. It is the old story of short-term gain – long-term pain.
When does it make sense to take out a debt loan to get out of debt? When you can use it to build wealth as you are chipping away at your debt load. If a person took out a Registered Retirement Savings Plan (RRSP) loan of $50,000 he/she could gain in a couple of different areas. First they would create a sizeable tax benefit and they’d also get the long-term growth potential. They could take their larger tax refund and put towards their debt. Another benefit is that the RRSP will probably earn a lot more in today’s market than the low rate of interest charged on the loan.
Another plus for the smart borrower is the boost to their self-confidence when they see their net worth actually growing instead of always being in the negative. This can spur him/her on to take other positive steps to reducing debt and building wealth.