Personal loans are famous for their flexibility, though most people fail to realize that they can also be useful in repaying your outstanding debts. It might seem strange that debt can be used to repay debt in an effective manner, but that tends to be based on little more than superficial impressions.
Here are three tips for using personal loans to help you reduce your outstanding debt:
Borrow at Lower Interest Rates
Assuming more debt to repay outstanding debt means replacing one short-term debt obligation with another. However, that can still be worth it so long as the interest rates on the new debt are lower than those belonging to the debt being repaid. Shifting the burden from more expensive debts to their cheaper counterparts is a time-honored practice, something for which personal loans are well-suited because you can wait and shop around until the interest rates are favorable. Remember that the interest charged is calculated as the principal multiplied by (1 + i)^n – 1, where i represents the interest rate and n represents the number of time periods in question. For calculating annual interest on debt that is compounded multiple times in the same year, n is represented by the number of times that interest is calculated while i is the stated interest rate divided by n. For example, 12% compounded semi-annually means calculating 1.06^2 – 1 for 12.36%.
Borrow to Boost Income
You have a couple of methods to speed up the reduction in your outstanding debt, either you can reduce your debt and thus your short-term debt obligations, or you can boost the income with which you can service those obligations. Most methods for boosting income are long-term rather than short-term prospects, but there are revenue-producing investments that can begin paying immediately. Bonds are perhaps the most common example, though preferred stock shares that pay regular dividends also merit consideration. Similar to paying down debt using more debt, it only makes sense to borrow for investment, if the rate of return on the investment is higher than the interest rate charged on the personal loan. You must keep in mind that potential investments can come with a range of risks, with riskier investments paying higher rates of return to attract investors. Although investing in riskier investments using borrowed funds can be tempting, you should only do so if the expected rate of return is higher than the interest rates on the loan and even then, you can still lose your investment. Expected rate of return is simply the sum of all expected outcomes. Using a simple example, if an investment has a 50% chance of no return and 50% chance of 12% return, then its expected rate of return is 6%.
Borrow to Boost Morale
Maintaining good morale is important if you are ever going to repay your outstanding debt. Each debt cleared is a small triumph that can help keep your motivation strong, while each day spent paying down a debt with little visible progress saps that same motivation. As a result, it can be worthwhile depending on your current state of mind to take out a personal loan to clear out some of the smaller debts even if the interest rates are not better.
Peter Coppola is a personal finance and insurance expert. He mainly writes for personal finance and insurance blogs. Click here to discover more about short term finance options.
Keeping an eye out on the personal loans available to you is a good way to spot a deal when it comes up. Take advantage of such opportunities even if you are struggling to repay your existing debt because personal loans can provide a much needed boost to your efforts.