How I’m working to escape my bad debt.
The “D” word…for Debt. Just about everyone is familiar with it, although some people are more intimately acquainted with it than others are. Debt is often the cause of disagreements and unhappiness among couples; and it often tends to creep into your thoughts when you’re busy doing other things, wreaking havoc!
I had so much debt when I got out of college six years ago, from credit cards to tens of thousands of dollars in student loan debt; I was literally swimming in it once I hit the “real world” after graduation. Okay, so who am I kidding? I still have a ton of debt that I wish I didn’t have, and I’ve been in the real world for longer than I care to admit most days.
However, the difference today is that the type of debt I carry now is not the same kind I used to own back then.
I do realize though, that debt is debt, no matter how you look at it: debt is money you just have to find a way to pay back. But there are certain loans you’ll probably prefer to carry, over others.
If you feel the same way, and are struggling with credit card debt, you may want to look into a few different methods to reduce the bad debt as you work on becoming completely debt free. I’ve managed to pull myself out of credit card debt by employing the strategies below:
Methods I’ve Used To Reduce My Debt
#1 Trading bad debt for good debt. This is not the best way to toss the debt, but I’ve tried it. I’ve taken a loan against my husband’s 401K to pay off credit card debt. This comes with a caveat though — that if you do this sort of thing, you MUST repay the loan or face the 10% penalty of early withdrawal.
Here is an MSN article that describes this approach further and also provides us with the pros and cons of going this route:
Borrowing Against Your 401K?
If your 401(k) plan allows loans (most do), you can borrow up to 50% of your vested account balance or $50,000, whichever is less. You usually have a maximum of five years to repay the loan, unless you are borrowing for a first home, which allows a longer payback.
The Pros
- There is no credit check.
- The interest rate is low.
- Paying yourself back provides you a pretty good return relative to cash account returns.
- The interest is tax sheltered in the sense that you pay taxes on the interest only upon retirement.
- It’s easy and convenient.
The Cons
- You’re losing the interest that you would otherwise have in your retirement account.
- You’ll need to repay your 401k with after-tax dollars. Future withdrawals will still remain taxable at future tax rates.
- You’ll incur a 10% penalty plus taxes if you’re younger than 59 1/2 and don’t pay back the loan.
- The loan is a consumer loan so it’s not tax deductible.
- This practice can be dangerous if it’s done repeatedly and ends up jeopardizing your retirement.
There’s also the suggestion that you should instead take out a home-equity loan if you happen to own a house. In this way, it’s more likely that you’ll be able to take a tax deduction on the interest you pay. But again, be very careful about this option, since you are putting your house (and for most of us, our biggest asset) on the line!
What I just discussed are some of the more controversial tactics used to pay down bad debt, so before you try this out, make sure you weigh all your options well. Here are more popular avenues to take for eliminating debt:
#2 Consider moving your credit card balances onto a single credit card with a good balance transfer credit card offer — like one that offers 12 months of interest free payments, or gives you a low, fixed interest rate over the life of the transferred balance.
#3 Set up a new payment schedule. This is one of the better approaches I’ve taken: paying my debt down bi-monthly, instead of once a month to cut back the amount of interest I was paying. If you can’t afford to pay anything more than you’re already paying out on a monthly basis, simply break your current payment amount into two payments and make the payments twice in a month, instead of once. For instance, if you pay $60 a month to a credit card, pay $30 at the beginning of the month and $30 in the middle of the month, and you will actually save on interest.
#4 Consider reducing the amount of money you are investing and/or saving in order to pay off debts. This is a good idea if you’re paying more interest on your debt than what you’re earning with your savings and/or investments. Once you’ve paid off your high interest debt, you can bump up the amount you are socking away and investing, and resume your savings plan.
A lot of posts on debt reduction strategies and debt elimination tactics provide general advice on how to go about dealing with your debt, but this post is one that’s less theory (though it’s in line with theoretical advice) and reflects more of what I’ve done in practice, since I’ve actually tried these approaches myself to try and improve my financial situation. I’ve applied these strategies to move away from the kind of debt I wasn’t too happy carrying and am quite satisfied that I’ve been able to chip away at my bad debt. These days, my “new” debt obligations are primarily house and business related. It’s a lot of money, but I feel a little better about paying for a house and business expenses than I did about paying credit cards with high interest, especially since I was paying for things that I couldn’t even remember that I bought with the credit cards!
Guest post by Tisha Kulak of The Helpy Helper
Image Credit: The Slipper Brick
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Yikes, I wouldn’t recommend borrowing against your 401k or your home. If there is some huge medical emergency, it makes sense, but I don’t understand how someone could own a home, but be in so much credit card debt that they have to borrow against their home. Right now our society has a problem where people are using credit cards to living above their means. People need to learn to stop putting things they can’t afford on credit cards. If you borrow against your 401k, you risk owing back what you borrowed plus a ton more in penalty fees…if you borrow against your home, you risk losing your home. It’s not worth it!
This is a little bit semantics, but #1 and #3 don’t actually do anything to reduce your debt. Moving debt is not the same as eliminating it. I only mention it because I see so many people who think that rolling credit card debt into a home loan somehow gets rid of debt, it doesn’t. Will it help? Maybe, but the only thing that reduces debt is paying it back or companies forgiving the debt.
For #2, I would note that a lot of loans, like mortgages only calculate interest once a month , so paying two payments often doesn’t save you any interest.
Just adding to the discussion.
@Emily,
I agree, I wouldn’t do it myself, it’s definitely high risk, but some people I know have done it and have worked it out somehow. But it really takes a lot of financial discipline and responsibility to pull something like this off.
IMO, if you’ve got strong financial discipline in the first place, then paying down debt through other, much more conservative means shouldn’t be too challenging.
As was mentioned in the post, trading down credit card debt for other forms of debt is something you need to consider very carefully and only if you’ve got a firm and solid financial plan that outlines how you’re going to execute this strategy successfully!
Let it be known how significant a risk it is to borrow against your 401K or house — you may get better terms this way, but there’s a greater risk involved if you don’t properly retire these loans.
@The Happy Rock,
Great points you’ve made. I guess the tactics here really all depends on your particular situation — especially for #2 where Tisha suggested splitting your payments in two.
Regarding #1 and #3, no, it’s removing the debt per se but making it be “less expensive”. I agree, it’s not “true debt reduction or elimination” but perhaps a step towards that end. For many who are in debt, every small improvement in payments can count.
Also, I guess the title of the post says it all — “eliminate credit card debt”. Sure you can cheat by saying that you’ve eliminated it by transferring or turning it into good or lower cost debt. Best way to get rid of all around debt is to pay it off.
I would like to caution everyone against borrowing on your 401K, for any reason.
If you leave your job or become laid-off, your 401K loan can become due in full. And, if you can’t afford to pay it off, you get hammered with all of the early withdrawal penalties.
It can become a pretty big finacial mistake.
You can also negotiate interest rates with your creditors.
Frankly the only option you have listed that has any merit is the last one. Take your lowest debt balance credit card and pay it down with everything you have. Then take the payment associated with it and apply it the next smallest debt. Do it over and over again. You will be surprised how rapidly you will eliminate all your consumer debt. Once you have completely eliminated your debt use the savings to invest. It is a simple but effective way to wealth.
Remember a credit score or FICO is simply a debt score promoted by credit card companies. My millionaire friends have credit scores of ZERO. Frankly I am working to lower my credit score to Zero also.
The trick that has worked for me is to pay off my debt in order of outstanding balance: from smallest to largest. Some suggest that attacking debt in order of interest rate (from highest rate to lowest) works too, but that is not my case.
When there is more than one loan with similar balances, I start paying off the one with the highest rate first.
This method has worked for me because it gives me a sense of accomplishment and inspires me to finish paying my outstanding debt.
im only using CC for my online business, besides that, no no no
Trying to pay off debt is something that can be very dicey at times. While we can argue on so many different ways of getting rid of our debts, the fact of the matter that it all depends on the circumstances of the individual.
What I mean by that is we all have different life styles and way of living. But don’t get me wrong, I do believe in those methods mentioned except for the one that says ” borrow from your 401k” Oppsss. That doesn’t work with me. I would rather leave as a last resort of sorts just in case.
My way of doing it is to pay the high interest rate credit cards and and start cutting them out and throw them once paid. Then I go to the next until all of them get paid which may take several years. just be patient and be consistent in your financial road map and your personal finance will be fine.
Thanks
Here in the UK a change to our Consumer Credit Act has meant that 1,000’s of people can challenge their creditors when it comes to paying off credit card or loan debts. Because the credit card agreements are invalid they have become ‘unenforceable’ in the eyes of the law. More and more people are engaging credit specialists to try and wipe clear their outstanding debts on this basis.
It is true that almost all credit cards actually have hidden fees in the fine print,particularly late fees.When you are choosing a credit card, it is always smart to compare credit card offers to find one with minimal hidden charges.
“IMO, if you’ve got strong financial discipline in the first place, then paying down debt through other, much more conservative means shouldn’t be too challenging.”
If people had strong financial discipline in the first place, they wouldn’t be in a jam in the first place. What’s wanted is a way to develop that strong financial discipline in the face of lender and retailer tactics to undermine it.
Cut back on unnecessary expenses. Even if you double or triple your monthly debt payment, your debt will not start to shrink until you start eliminating your unnecessary expenses. Stop buying expensive clothes and luxury items. And cut back on eating out and movie nights.
Recently a top news show had a segment on credit card companies. The gist of the segment was that credit card companies are as bad as “loan sharks” with their astronomical interest rates and fees. They are forcing people to look for alternative ways to get out from under these high interest rate credit cards. Some people can follow a plan on their own, but there are many people who seek the help of debt settlement companies.
Because debt settlement is not yet regulated, there are many unscrupulous companies that are taking advantage of people. If you are considering a debt settlement company, you should do so only if you can not afford to pay the debts as agreed. Debt settlement does work, but make sure you consult with a company that has attorneys licensed in your home state to ensure your selecting a reputable company that is bound by a code of ethics and is knowledgeable on the laws in your state.
I like how you’ve added the pros and cons in your article. It’s always good to see and that’s usually how I make decisions. Great article and great methods on eliminating credit card debt. Thanks for sharing with us. I definitely learn something new everyday.