Should you Ever Pay off Old Loans With New Ones?

Taking on new debts to pay off your old ones sounds like a problematic debt spiral, and in some circumstances it can be exactly that. In other situations, though, the idea can start to look quite attractive and like it could potentially help make your situation more manageable. Is it ever a good idea to pay off old debts with new?

The Advantages

In principle, there will be an advantage to paying off an old debt with a new one if you can get a better deal on your new loan than you are getting from your current lender. Paying off one loan with a newer one that has a lower rate of interest is, in many ways, the same as switching provider for a utility or insurance product. You simply move from one company to another, because with the new one you will pay less monthly and/or over the full term of the loan. Depending on your circumstances or needs, a better deal could mean a lower interest rate, saving money both monthly and in total, or it could mean a longer term which means you pay back more overall but have significantly lower and more manageable repayments.

This kind of situation might arise because you have held a loan for some time and better deals have come on the market. Alternatively, it may be that you didn’t get the best deal when you took out the loan, for example choosing an ultra-high-interest payday loan that you are now struggling with when you could have borrowed the same amount elsewhere at a much better rate. If you are genuinely struggling on your current deal and the new deal would be enough of an improvement to solve your problems, it is best to switch as soon as possible or your credit rating may fall and you may no longer have access to the better deal. If you are struggling with multiple debts, on the other hand, then a specialist debt consolidation service may be a better way to move what you owe and make things more manageable.

The Problems

In principle, any situation where you could get a better deal on the new loan is one where it is worth taking out a new debt to pay off an old one. In practice, however, things are not usually that simple. With the exception of credit cards, where balances can commonly and easily be transferred for fairly low fees, switching loan providers is not as simple as changing utility or insurance providers. For one thing, you may or may not be eligible to take out the second loan. There are online tools that can help you work out whether you are.

There is another major factor that affects whether you will gain from the switch. In order to switch, you will need to take out a new loan for the full settlement value of the old one, and then pay the latter off at once with the funds you have borrowed. This is where potential problems come in, as your old loan may well carry early repayment fees. It is important you look into these fees before making any switch. There may be multiple separate charges, so make sure you are aware of them all. It is only worth switching if you stand to gain more from changing deals than you will lose in early repayment charges.