Q: I owe about $7,300 on two credit cards. I have two certificates of deposit maturing, for about the same amount of money. My question is, do I pay off those cards, or do I take a loan using those CDs as collateral and pay about 4% interest on the loan to pay off the credit cards? I am thinking it will take me a long time to save that much money again.
A visitor, Rochester, NH
A: I get asked this type of question all the time. What people really are asking is: “Should I use debt to pay off debt?”
At least that’s how I view it.
If you are thinking of using a home equity loan, home equity line of credit, consolidation loan or, as this reader wants to do, take out a loan using your CDs as collateral, to “pay off” an auto loan, credit card debt or whatever, do this for me.
Get a small rock that can fit into the palm of your hand.
Go ahead; just do it.
Once you have the rock, move it back and forth between your hands. Do this a couple of times.
Are you getting my point?
When you use debt to pay off debt, you are not paying off the one debt. You are merely transferring it to another loan. You are shifting your debt load, not lifting it. It’s like moving the rock from one hand to the other.
Sure, in some cases, the math says you might save money by reducing your interest cost by shifting the debt to another loan.
But what I typically find is people shift their debt and then go right back and run up more debt. They don’t actually get ahead.
Painfully paying off your debt without using more debt has the opportunity of searing into your memory how hard it was to actually pay it off.
So, in this case, I wouldn’t take out another loan. I would put the credit card cards away. I would redo my budget and look for any and all ways to cut my expenses. Whatever money I could squeeze from my budget, I would apply it to the credit cards.
For example, could you save, say, $30 or $40 a month by reducing your cell phone plan to the basic plan? Yes, you might not be able to get Internet or send unlimited text messages, but you would be making a dent in your debt.
Could you cut eating out or at least cut back?
Could you get a second job, just for a short time?
There’s another alternative.
If you have a relatively stable job, and you are not concerned about being laid off, you could cash one CD out when it matures and use that to significantly pay down the credit card debt. Keep some money for emergencies.
With the debt that is left, you should be able to cut your expenses and get rid of it.
(Photo by Andres Rueda )