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    5 Dangerous Debt Payoff Strategies

    By Wise Bread | U.S.News & World Report LP – Mon, Sep 26, 2011

    Whether you're carrying a few hundred or a few thousand dollars in loans and credit card debt, making a commitment to get out of debt is a noble goal--unless you're using the wrong payoff strategy.

    Some self-discipline with the budget and a strategic debt payoff plan will put you in a better financial position, but you'll also need to make wise decisions about how you pay off that debt. Paying off large amounts of debt all in one go or using up a savings fund aren't always the wisest financial moves.

    [See 10 Ways to Start Earning Extra Money Now.]

    Here are five dangerous debt payoff strategies to avoid:

    1. Paying off credit card debt too fast. If you're a habitual credit card user and decide to pay off credit card debt in one big swoop, you'll enjoy the satisfaction of clear credit balances for a while--but could end up racking up more credit card debt in the near future. If your credit card spending is out of control, you'll need to work on breaking the habit of spending with credit cards altogether. Paying off that credit card debt quickly without making some adjustments to spending habits could lead to another credit card spending "binge." Wean yourself off credit card spending so that you don't fall back into old habits.

    2. Using emergency funds. Your emergency fund needs to be one of your "no touch" accounts until you're facing a real emergency. If you use up your emergency funds to pare down that debt load, you'll have to deal with financial instability when faced with medical bills, a family emergency or another situation that demands some quick cash. Avoid tapping into your reserves just to pay off debt. Even though you would be eliminating a debt load, you won't have any type of financial cushion to fall back on. Look for ways to earn more money or sell assets so that you have more cash available for your debt payoff strategy.

    [See The Secret to Living Well on $40,000 a Year.]

    3. Tapping a home equity line of credit. Borrowing against the equity of your home can give you some extra cash for large purchases and even pay off some debt. However, this strategy can be a bad move in the current economic climate when housing prices continue to drop. When the value of your home drops and you end up having to sell the property, you'll end up owing more than you bargained for. Avoid tapping into a home equity line of credit unless you're certain that you will be staying in your home for several years, and that your home has the potential to increase in market value.

    4. Withdrawing from a 401(k). You've worked hard to build up a healthy balance in your 401(k) account and have been consistent with your contributions. Don't let all that hard work go to waste by withdrawing early. While withdrawing funds from a 401(k) may seem like a simple way to get a lump sum of cash to put toward a debt repayment plan, you will be paying fees for an early withdrawal and will be clearing out those much-needed savings for retirement. Look for other, less costly ways to pay off debt so you can leave your 401(k) intact for as long as possible.

    [See 401(k) Mistakes to Avoid.]

    5. Filing for bankruptcy. Filing for bankruptcy can seem like an easy fix when you're overwhelmed by your current debt load or can't seem to put together a workable debt payoff plan. Keep in mind that the effects of filing for bankruptcy can last 10 years and creditors and employers will see the bankruptcy filing listed on your credit report. Potential creditors can turn you down for a new credit line when they see bankruptcy on your record, future landlords might think twice about renting to you, and employers that conduct credit checks will see the bankruptcy filing on your credit report.

    It can take years to repair your credit after bankruptcy so you need to do whatever you can to pay off that debt on your own. Working with a debt counselor instead of a bankruptcy attorney can help you get a better perspective on your current financial situation and formulate a debt payoff plan that works. If you pursue a debt relief program, you may be able to settle your debt without going down the bankruptcy route.

    Sabah Karimi is an award-winning Yahoo Contributor and WiseBread.com's guide to travel rewards credit cards.

     

    1 comment

    • Peter
      Peter  •  7 mths ago
      With respects to Sabah Karimi, these are not very helpful if you're serious about debt mitigation. In fact, except for the bit about 401k's, I disagree entirely.

      1. Paying off credit card debt too fast. The high current limits for most revolving credit cards are so usurious that you are best advised to pay them down in as big a hurry as you can, or forget them entirely and declare bankruptcy. Some advice: pay bank credit first. Store credit cards apart from foodstuffs can be cut up and ignored entirely for much longer. Start with the absolute realization that your credit history is gone for the next 7 years. Pay off the highest interest first and work backwards. Pay nominal fees (interest and small principal payments) on the others until they are all reduced to no more than 1-2 months of your annual expected salary. You blew it, so face the music to reduce total outlay. Sabah's approach makes more money for your creditors, and they already are banging you for all you are worth. They will not love you more and do not care if you die: they have insurance for that. If you are going to go back into debt to pay these off, shame on you. See item 5.

      2.Using "emergency funds". If you are in serious debt trouble, these don't exist. If you're not, you won't use them anyway.

      3. Tapping a home equity line of credit: Since you will never be able to get more than 50% of your home's equity in these type of loans, there's no problem here if you can take the money out to stop the bleeding. The interest on these is much lower than the credit card balances and is routinely a good deal if you are younger than 50. Older than that and bankruptcy is probably the way to go if you are independent. However, if you are in serious debt trouble it is unlikely that any bank or mortgage company will underwrite any such credit for you unless at exorbitant rates. Beware: an equity credit line should be only slightly above a standard 15 or 30 year mortgage rate and should be fixed. You don't want a product that bundles your debt at rates higher than your current creditors that also imperils your house.

      4. Withdrawing from a 401k. A bad idea only because the government doesn't care if you starve. You didn't pay taxes on the income you are tapping, so not only do they want their share, they want to penalize you 30% of what you take to punish you for being poor. Serves you right for voting for them. In fact, if you took out your money before the crash in 2008 you probably netted a profit anyway, even with the penalties. But let's face it, this is only a "201k" now anyway so there isn't that much left to take.

      5. Banks and insurance companies and credit card issuers are your enemies. They actually profit from your suffering and package their products to entice you to spend more than you can possibly pay so that you will pay just late enough to allow them to charge the most confiscatory rates. This makes you their best customer: a sucker. You should really deny them the chance by switching to a cash mentality: all you need is a debit card and some steady income. Go to a smaller community bank to take advantage of higher rates, especially if that bank is slow and inconvenient to use. And if you have to file bankruptcy, do so without regret. As I said: they will attempt to nail you regardless. The difference between a bad payment history (kept for 7 years) and a bankruptcy history (kept for 10 years) is not significant. There is no point worrying about your credit history at all. The best credit history is NO credit history. If you have enough cash saved, regardless of your credit history, or immigration status the banks will kiss your feet.

      In point of fact, the advice in this article is best for the banks and credit card companies, not for you.
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