Using Personal Loans to Lower Debt: Doing it the right Way
You want to lower your debt, and personal loans might be the secret you’ve been looking for. There’s just one problem: debt consolidation, by definition, doesn’t lower your debts. It just rearranges them. That doesn’t mean that you can’t use loans as part of the process, but you have to make a detailed plan to go along with the loan. In other words, lowering your debts requires a strategy – not just a financial product.
The Loan Type
The first thing you need to do is start researching loans. The ideal loan will consolidate all of your personal debts. If you can’t consolidate using just one loan, you’re going to have to use multiple loans. It’s not ideal, but it will get the job done.
Because most lending institutions cap personal loans at $25,000 (some cap the maximum loan amount at $15,000), it’s going to be difficult to consolidate larger loan sizes under just one loan. The bank is taking a tremendous amount of risk with a large personal loan since the loan is usually unsecured. Keep this in mind when shopping lenders.
If you’re consolidating credit cards, consider using a balance transfer. Many credit card companies offer promotional rates on new cards – especially for balance transfers. Usually, these introductory rates are far below the rates you’ll pay for a personal loan. They’re also lower than the normal rate charged for regular purchases.
Your Savings
Instead of doubling up on your loan payments, like most people do, consider taking the savings you realize from the consolidation and putting it into a savings. This is the real secret to paying down debt fast. Most people take the savings they realize and spend it or use it to pay down the principle. This is a mistake most of the time because it doesn’t reduce your monthly payment and it puts you at greater risk of default if you ever have financial problems down the road.
For example, let’s say your total monthly debts are costing you $500. You’re able to get a personal loan to consolidate everything, and your monthly payment drops to $300 because of a lower average interest rate and a longer loan term on the consolidation loan. Congratulations, you just saved $200 per month. Instead of putting this against the principal, put it into your savings.
Your Investments
Take that savings and invest it in something that will compound over the life of the loan. Ideally, you would use something that minimizes the impact of taxes. For example, a high cash value life insurance policy will defer the taxes due on all of the savings that build up inside of the policy. Most high cash value policies will allow you to pay off your consolidation loan 5 to 10 years early.
Municipal bonds are another investment that eliminates the burden of taxes on your investment gains while helping you to accelerate your loan payments.
In both cases, the idea is the same: you make your minimum consolidation loan payment every month. Meanwhile, your savings continues to grow. As the savings grows, there will come a point when the savings equals the total payoff amount of the loan. At that point, you strategically borrow from your life insurance policy to pay off the debt (you can get help with this from the life insurer – most of them are very familiar with this strategy). Since life insurance policy loans never need to be repaid until your death, you can choose to put the policy “on hold” or repay the policy loan at your leisure. If you don’t repay the loan, the death benefit is used to retire the loan when you die. Any leftover death benefit proceeds are paid to your beneficiary.
With municipal bonds, you simply cash out and retire the loan.
With this strategy, you have a savings that can be used to make loan payments for you at any time before the loan payoff date if you run into financial trouble. If you never run into financial trouble, savings gives you the same effect as making additional payments towards the principal. The only difference is increased flexibility in how you pay. What could be better?
Peter Coppola is a personal finance consultant. He also blogs on the topic where he loves passing on his knowledge and tips to borrowers. Visit EasyFinance.com for more information.
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Category: Loans
