How Debt Shifting Can Help You Pay Down Balances Faster
Carrying debt can be stressful, plus the interest you'll pay on your balance can create financial strain.
Debt shifting is a strategy to make it easier to repay your debt faster; but, like all debt repayment strategies, you need to understand the pros, cons and potential pitfalls to determine if this repayment method is the right choice for you.
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How Debt Shifting Works
Debt shifting is a strategy that makes it easier to pay down your existing balance. By shifting your debt onto a new account that has a lower interest rate or more relaxed repayment terms, you can save on interest and put more of your payments toward your principal. Debt shifting can give you a chance to catch up, but it has drawbacks.
Martin Lynch, president of the Financial Counseling Association of America (FCAA), explained that debt shifting can signify that inflation is taking a toll on borrowers. "Any significant increase in the numbers of consumers moving debt is often seen as an indicator that consumers are struggling to maintain their obligations in the face of rising inflation, which is what we've seen since the end of the pandemic," Lynch said.
While there are many ways to move debt, Lynch highlighted the importance of considering multiple factors before committing to any one strategy.
0% Interest Credit Cards
According to Lynch, many consumers use 0% interest credit cards to repay their debt. If you have a balance on a credit card with a 22% interest rate, you could potentially transfer that balance to a 0% interest card, buying you time to pay down the debt without the interest adding up.
Opting for a 0% interest credit card might seem like a logical choice. "But the devil is in the details," Lynch explained. "That 0% rate will only be in place for a year or so, which means you have a finite opportunity to transfer your balances and pay them off."
There are other potential costs, too. You'll need to consider the cost to transfer your balance, which is either a set fee or a percentage, usually between 3% and 5% of the amount that you transfer. After you've paid those costs to transfer your balance, can you afford to attack the balance on the 0% interest card during the period when that interest rate is still at 0%?
"After that promotional period expires, the card will carry an interest rate of its own, and it won't be anywhere near zero," Lynch said. "In sum, the strategy can work, but you have to account for costs and have enough funds to pay down your balances before the 0% rate goes away."
Consolidation Loans
Consolidation loans are loans that combine multiple debts into one loan. For example, you could take out a loan and use that money to pay off your credit card and car loan. If your new loan has a lower interest rate than your previous loans, it might make financial sense to consolidate your debts and pay off the balances at that lower interest rate, but Lynch explained that consolidation loans have drawbacks, too.
"First, you have to determine the true cost of the loan," he said. You might pay a substantial origination fee that could cost up to 10% of your loan balance. Some loans come with other closing costs. While you can often roll those expenses into the loan, you'll ultimately be paying more for your loan over time.
"The greatest risk of a traditional consolidation loan comes afterward, when you're paying off the new loan at its lower rate and your credit card balances are back at or near zero," Lynch said. "For some consumers, that seems like a green light to start using their cards again. Unfortunately, because they never addressed the root cause of their high balances, they may head back into trouble."
Debt Avalanche Strategy
The debt avalanche strategy, another type of debt shifting, involves paying down your balances on the accounts that have the highest interest rates first. At the same time, you continue making minimum payments on all of your accounts, but you put extra money into the account with the highest interest. Once you pay off that first account, you'll repeat the process by focusing on the account with the second-highest interest rate.
"The avalanche method saves the most money, but progress may appear slow if the accounts with the highest rates also have the highest balances," explained Lynch.
Debt Snowball Method
While it may take a while to see your progress using the debt avalanche strategy, you'll usually see results more quickly with the debt snowball method. When using the debt snowball method, you'll work to pay off your debt with the smallest balance first, but you'll continue making minimum payments on all of your debts. Once you've paid off that smallest account, you'll put everything you were paying on that account toward paying off your next-smallest debt.
"This can increase consumer confidence in the strategy itself, as they see one count after another being paid to zero," Lynch said. "The snowball method won't save as much money over the long run as the avalanche method, but it works."
Additional Tips for Paying Down Balances
According to Lynch, it's important to be careful about which companies you trust to help you pay down your debt. "We strongly recommend talking with a counselor at an FCAA-member agency before committing to any of these debt-shifting strategies," he said. "Our counselors can review your finances with you and share the pros and cons of any debt relief strategy to help you find the best fit."
He cautioned borrowers to look out for consolidation loan scams, which appear to be on the rise. "Most for-profit debt settlement companies cannot access your credit reports -- they have no permissible purpose to do so, but certain lenders will gladly access your reports looking for consumers with high debt balances," explained Lynch. "Those lenders may contact you offering a loan you have no hope of qualifying for, but then may share your information with a settlement company that will happily charge you a fortune based on their sales pitch that you will pay off your debt at 50 cents on the dollar."
However, Lynch explained that you can be sued at any time for not paying your creditors, regardless of whether you're working with a debt settlement company.
"These scams are waiting until you've saved enough to propose a settlement," he said, "but in the end, their high fees will leave you saving relatively little -- if you're fortunate enough to settle even a single account."
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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