Wednesday, August 20, 2014

4 Wrong Ways to Pay Off Debt

Not all options to pay off debt are good ones.
4 Wrong Ways to Pay Off Debt photo
When considering methods like obtaining a home equity loan or an increased line of credit, cashing out your 401(k), and cash payday advances, you should realize these are simply quick fixes that will increase your total debt and financial risks.
Knowing the wrong approaches to reducing your debt will help steer you in the direction of the right ones.

1. Don’t Leverage Your Home to Get Out of Debt

Home equity lines of credit, or HELOCs, are good for things like home repairs and updates. But if you use them to reduce a heavy debt, you are putting your home at risk since you are putting it up as collateral.
The ultimate loss of your home in foreclosure makes this too risky a path to take. You can’t plan for the future—things like divorce, illness (particularly the medical bills that follow), job loss or other unforeseen events can drain your bank account.
If that happens when you are using a HELOC, you might not be able to pay it back: debt is better than homelessness.

2. Don’t Increase Your Line of Credit

Asking a bank or credit card company to increase your line of credit often results in greater debt and less attainable payoffs, especially since the interest rate will likely increase as the line of credit is extended.
While taking on more credit—and more debt—is better than leveraging your home, it’s still a way to bury yourself in more unpaid bills.

3. Don’t Take Route 401(k)

Even if you are eligible to take money out of a 401(k) plan, you will be required to pay federal taxes on it when you do so.
If you take a loan out on your 401(k), you can be taxed on the money as income when you receive the loan—and then again later when you withdraw the money for retirement. Being taxed twice is never a sound financial move.
It is better to let the 401(k) sit and earn interest rather than cost you loan interest or tax dollars. Save it for your retirement.

4. Don’t Get Cash and Payday Advances

Cash and payday advances should be for emergencies only—not to handle debts. The payday advance can carry an even larger interest rate than those attached to your debts, sometimes astronomically.
The cash advance puts money in your hand, but ultimately, it only increases your total debt. You’ll be subjected to minimum fees and percentage fees—or both.
Again, unpredictable events can harm the payoff of these added debts as well as the original debt you may have sought these advances to cover.

Beware the Bankruptcy Option

Bankruptcy should only be considered as an option when all other paths have failed, as it will seriously hinder your ability to get a loan for a while. For example, you shouldn’t even consider applying for a mortgage for two years after your bankruptcy has been discharged.
If you are considering bankruptcy, seek proper credit and bankruptcy counseling before filing. There are several different forms of bankruptcy to consider, and a counselor can advise you as to which best fits your circumstances.
Bankruptcy is a legal proceeding with specific consequences. You need an attorney to handle the details of a bankruptcy.

Reduce Expenses, Budget Better, Reduce Debt

You can’t get in incredible shape by going to the gym for just one day, one week or even one month. Likewise, you can’t get in good financial shape if you don’t budget accordingly until your debts are paid.
The best way to do this is to create a long-term budget and stick to it. Involve your family, go over expenses and see what you can do without.
It takes discipline, but it’s the best way—for while there’s no quick fix to getting out of debt, you can eliminate it over time.

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