More Suggestions for Paying Down Debt

In a previous post, we suggested paying bills down by paying all bills on time, and by paying more than the minimum amount due on the bill with the highest interest rate.  While this is an excellent strategy, it is only one of many that can be used to pay down your debt.  In this post we will present several other good strategies for getting your debt paid down.

Do not Acquire New Debt
When trying to pay down your debt, do not apply for new credit cards or loans until you have brought your finances back in order.  Also, during this time, avoid using your credit cards when you're making a purchase.  Instead, use cash, checks or debit cards to pay for a purchase.  It's difficult enough to pay down credit card debts even when you're not accumulating new debt.

Balance Transfer
Consider transferring the balances on high interest credit cards to a card having a low interest rate.  You may be able to consolidate multiple credit card payments into a single payment.  In case you don't have a low interest card, you may want to look for one.  You may even get a card with a 0% introductory rate.  However, you need to check the duration for which the introductory rate would remain at the low rate.  If it's quite long, then you'll probably have enough time to pay off a good chunk of your credit card bills at the low rate of interest. That could save you a lot of money in interest charges.

If you request a balance transfer, ask your creditor if they charge a fee for the transfer. Request that the fee be waived as a one-time courtesy.

Before you act, however, be sure to examine the offer closely.  If the interest rate after the introductory period is higher than the rate you're paying now, you may have to switch again at that time.  Be aware that banks have caught on to the charge card hoppers who switch from card to card to take advantage of the low introductory rates.  Many of these offers now stipulate that if you transfer balances from the new card within a 12-month period, the normal interest rate will be applied to all outstanding balances retroactively. That could result in wiping out all or most of the benefit of the balance transfer.  Be sure to read the fine print.

Pay Off the Lowest Balance First – The “Snowball” Effect
A tactic many employ is to pay smaller bills off first, then take that payment savings to attack other bills.  Here’s how it works -- start with the account having the lowest balance and make extra payments (pay more than the minimum) toward it every month.  Continue to pay the minimum amount due on other accounts.  As soon you pay off the account with the lowest balance, move on to the account with the next lowest balance and repeat the same process.  While this approach may not get all your bills paid off as quickly as directing the additional payments to the card with the highest interest rates, it can provide the reinforcement you need in order to continue making the additional payments by seeing your accounts paid off more quickly.

Use Savings and Investments
It sometimes makes sense to make withdrawals from your savings and investments and use the proceeds toward debt repayment, particularly when the after-tax return on the savings or investments are lower than the after-tax interest rate expense on your debt.  With most savings accounts currently paying extremely low interest rates and most other investments earning very low or even negative returns, this is often the case now.   As an example, if you are in the 25% tax bracket and you are paying interest rates of 15%, unless the return on your investments is more than 20% before taxes, it may make sense to use those funds to pay down your debt; and these days, very few savings or investment accounts are earning anything near 20%.  Using those funds to pay off that debt is essentially the same thing as earning that 20% return without any risk on your part.  In general, the higher the interest rate on your debt, the more attractive using savings and investments to pay off your debt becomes.

Borrow from Your 401(k)
If you have a 401(k) plan you may be aware that most such plans have a feature that lets you borrow against the retirement account.  Interest rates are usually much lower than the rates on credit cards.  Thus, 401(k) plan loans may be a good source of funds for paying down debt.  Another benefit to this approach is every penny in interest paid on a 401(k) loan goes directly into the borrower's 401(k) account, not to the administrator of the account.

But there are drawbacks to borrowing from your 401(k).  The loan and interest will be repaid with after-tax dollars, and the interest you paid will be taxed again when you withdraw money from the 401(k) years later.  Additionally there are other potential issues you should be aware of such as limits on terms, repercussions if you leave your employer, etc.  We recommend speaking to a CPA if you’re seriously considering this approach.

Borrow Against Your Insurance
If you have life insurance with a cash value, consider taking out a loan against the policy to apply toward reducing your debt. The interest rate on such a loan is typically well below the commercial rates.  In order to avoid a benefit reduction, however, be sure to repay it as soon as you are able.  If you were to pass away before the loan is paid off, the outstanding balance plus interest would be deducted from the face value of the insurance, and only the remaining balance of the benefit would be paid to the beneficiary.

Borrow from Family or Friends
Perhaps you have family or friends who could provide you with a loan.  If so, there's a good chance that they would be willing to give you a very favorable interest rate.  They may even tolerate a late payment or two.  But you should always have a written agreement, in which the interest rate and repayment schedule are clearly spelled out in order to avoid any misunderstandings.  Also, be sure to strictly adhere to that schedule

Change Your Lifestyle: If you're thinking of using credit cards to cover your daily expenses (such as gas, utility bills and groceries), it's probably time to change your lifestyle.  Find a part-time job, use public transportation as much as you can, and consider relocating to a less expensive home, before resorting to using credit cards for your daily expenses. You may also be able to sell some of your old items online in order to earn some extra cash to help repay credit card bills.

Renegotiate Terms with Your Creditors
If you've done all you can, i.e., savings and investments are gone, you don't have anything left in a 401(k) to borrow against, and you've borrowed all you can from friends and relatives, what's left?  Seek legal protection?

Let your creditors know your situation. Tell them that if you are unable to renegotiate terms, you'll have no other recourse but to declare bankruptcy.  Ask for a new lower repayment schedule and/or request a lower interest rate.  Your creditors want to receive payment; faced with the possibility that you may seek legal protection, they will do what they can to protect themselves against a total loss.  It's worth a try.  If you don't wish to do this yourself, there are organizations that can help you do it.

When you succeed in paying off your accounts and the balances reach zero, consider contacting your creditors to close the accounts one-by-one.  However, if you're thinking of buying a home or a vehicle, or making other major purchases in the near future, avoid closing the accounts because it will reduce the length of your credit history and reduce your credit score. This in turn, will adversely affect your chances of qualifying for a loan with the best possible terms and conditions.  So, depending upon your financial goals, you may not wish to close your accounts immediately after you've paid off the balances.  Just avoid incurring more charges on those accounts until you're in better control of your finances.