6 Foolish Ways to Pay Down Debt

By Kentin Waits on 13 June 2017 0 comments

Living paycheck to paycheck is even more challenging with loads of high-interest debt. At the end of the month, you've worked hard and barely made a dent in the principal you owe.

Sound familiar? If so, it's time to develop a repayment strategy that avoids common gimmicks and shortsighted solutions that only dig a deeper hole. Here are six terrible ways to get out of debt.

1. Depleting your retirement account

Taking a loan against your 401(k) account is a trifecta of bad ideas. First, your employer may not allow you to make new contributions until the loan is repaid in full. Second, because of those loan payments, you'll take home less money — a situation that can turn household budgets upside down and may tempt you to revert to bad credit habits. Third, if you leave your job, the outstanding loan amount must be repaid immediately. Not able to swing it? Then you'll get hit with early withdrawal fees and be responsible for income tax on the balance. (See also: 7 Traps to Avoid With Your 401(k))

2. Consolidating debt with a high-interest loan

Whack-a-Mole is a classic arcade game, not a debt repayment strategy. Consolidating debt into a single loan only works if the interest rate is low (that is, significantly lower than your average credit card rate). Proceed with caution. Understand the terms of any loan that's offered and don't be seduced by low monthly payment amounts that actually keep you paying for a longer period of time. (See also: 5 Ways to Pay Off High Interest Credit Card Debt)

3. Borrowing against your home

What's worse than being in debt? Being homeless and in debt. If your current debt is unsecured (that is, not tied to any property as collateral), why secure it by folding it into your mortgage? If you don't pay back an unsecured debt, you'll end up with a bad credit score. But — and this is a big but — if you don't repay a home-equity loan, you'll end up with a bad credit score and a foreclosure.

4. Draining your emergency fund

An emergency fund serves a singular purpose: It's a safety net that helps people cope with a job loss or unexpected expense without resorting to high-interest credit cards. Tapping your emergency fund to pay off unsecured debt today jeopardizes your financial security and can leave you exposed to even higher debt levels tomorrow. (See also: A Step-by-Step Guide to Creating Your Emergency Fund)

5. Working with a debt settlement company

Sure, convincing your creditors to accept a lump-sum payment of less than what's owed sounds fantastic. But debtors beware: Sometimes debt settlement can make things worse. As part of the lengthy and fee-riddled settlement process, you must stop paying your debts — an act that triggers collection calls, late fees, and negative credit reporting. And even if all your creditors agree to the settlement terms (there are no guarantees), it'll take years to rebuild your credit score.

To better understand your debt, connect with a nonprofit credit counseling service instead. (The FTC has some tips on finding and choosing a reputable credit counseling service.) These agencies help consumers review their budgets and design a repayment plan that's realistic and effective. They may negotiate with creditors on your behalf to lower penalties and interest charges, but they won't go to the drastic and credit-damaging lengths that many debt settlement companies do.

6. Borrowing from family or friends

While borrowing from those closest to you may seem like a reasonable way to avoid predatory debt-settlement services and high-interest loans, it's a quick way to shorten your Christmas list permanently. One missed payment or one obvious personal splurge builds ill will that's difficult to overcome. Unless you're absolutely certain you can pay back the money without a single hiccup, avoid mixing finances with family and friends.

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6 Foolish Ways to Pay Down Debt

 

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