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Borrowing to pay off credit cards can make matters worse

Taking a loan to pay off credit cards

Taking a loan to pay off credit cards must be done carefully so the borrower does not end up in worse financial shape. Photo Credit: Getty Images iStockphoto / Courtney Keating

Many people who take out loans to pay off credit cards and other obligations wind up worse off, with more debt and more stress than before they applied. Some people, though, successfully use debt consolidation loans to turn a bad financial situation around.

Determination is essential if people want to avoid winding up deeper in the hole. Otherwise, the overspending that led to the credit card debt just continues unabated.

“People will use a consolidation loan to pay off their credit card debt, and within a year they’ve run up their balances again,” said Bruce McClary, a spokesman for the National Foundation for Credit Counseling, who has worked as a debt collector, loan representative and credit counselor.

People who took out debt consolidation loans were no less likely to file bankruptcy than people who didn’t, according to a research project that used the Panel Study of Income Dynamics, a long-running survey of Americans’ finances.

Rates on unsecured personal loans may be lower than prevailing credit card rates — or substantially higher. Rates range from about 3 percent all the way up to 36 percent. Secured loans and borrowing from a 401(k) plan carry substantial risks.

Here’s a checklist to use if you’re considering a debt consolidation loan:

Objectively assess your situation.

If your credit card balances, medical bills and other consumer debts equal half or more of your income, consider consulting both a bankruptcy attorney and a credit counselor. You’re unlikely to be able to pay off your debt within five years, which is typically the longest period you’d be forced to do so under a Chapter 13 bankruptcy repayment plan. Most people with unmanageable debt can qualify for a faster Chapter 7 filing, which erases consumer debt within three to four months.

Opt for the shortest possible loan.

To minimize the interest you’ll pay, keep loan terms to three years or less if possible. Five years is the maximum you should consider.

Look for direct payment of creditors.

Some lenders will pay your credit card company directly, removing the temptation to use borrowed funds for another purpose.

Consider closing your cards.

If you don’t trust yourself not to run up more debt, shuttering accounts may help you learn to live within your means. People who closed accounts were more likely to pay off their debts than those who left them open, according to a study by researchers from the Kellogg School of Management at Northwestern University.

CREDIT REMINDERS

Avoid high-cost loans when consolidating debt. Calculate the total cost of the loan — the monthly payment times the number of payments, plus any fees — and compare it with what you’re paying now.

Some lenders offer low payments, but have sky-high interest rates and long terms that keep people in debt longer.

Credit unions often offer the best rates and terms on personal loans, but check online lenders as well.

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