Eliminating Debt: Choosing The Right Strategy
For most of us, once we finally come to a decision to take action, we expect immediate results. That’s human nature.
But, let’s face it…most things in life that are worth doing take time to accomplish. They almost always take plenty ofpatience, effort, and sacrifice, too. So it is with eliminating debt. In all likelihood, getting into debt has been a gradual process for you. Most people accumulate excessive credit card debt over several years. Their debt gradually mounts, building up from a point where it is burdensome but manageable to a point where it eventually becomes unmanageable. Unfortunate life events like job loss, divorce, or illness onlyaccelerate the process.
Feeling impatient about your debt is understandable. But, just take a moment and ask yourself a few questions: “How long have I been carrying this debt?” “When did I receive my first credit card and when did I begin using it?” “When was the last period of time that I was debt-free?”
So you see, it took time for your debt to build up and it will take time to eliminate it. That is, unless you win the lottery. However, we don’t recommend wasting your hard earned money on the unlikely chances presented by the numbers’system.
Can I Eliminate Debt on My Own?
The purpose of this module is to examine some of the various strategies you might use to eliminate your debts on your own. You may have already received many suggestions for eliminating debt. You may have even received dozens of unsolicited notices about debt reduction methods in your mail or on your computer. This module examines the pro’s and con’s of some of the strategies that you have probably already heard so much about. You will note that some of the more traditional methods of eliminating debt, like balance transfers and debt consolidation loans, hold many potential pitfalls and don’t turn out to be so effective at reducing debt, after all.
The Problem with Balance Transfers and Cash Advances
Many people have played the balance transfer game for years. In playing this game, of credit card “switcheroo”, they have created conditions whereby they have more credit cards open and heavily loaded than they ever intended. After a while, its usually hard to keep them straight.
Balance transfers are like ideas that work far better in theory than in actual practice.
In theory, transferring balances makes sense because you are typically transferring the debt from an “expensive credit card” (i.e., one with a high balance and/or high interest rate) to a “less expensive” card (i.e., a brand new card or card that has a low balance and/or low interest rate). But, in reality, this system hardly ever works out well and it doesn’t help you break the cycle of being in debt.
The same is virtually true for cash advances. Often, these so called “advances” come in the form of checks your credit card company sends to you that you are then encouraged to use to pay off the balance on another credit card. Basically, the problem with both of these types of so-called debt elimination strategies is that they are really not debt elimination strategies at all. With balance transfers, you are really “moving” debt, not actually eliminating it. Because when you transfer a balance you wind up with two credit cards instead of one, both of which might get “maxed” out again if you are not extremely disciplined. One card has been emptied and one card has a new, lower balance. The relatively low balances on both of these cards may tempt you into using both cards more often and running up your debt all over again.
A cash advance is just another loan…another debt to pay off. In addition, just because a cash advance is “easy credit” doesn’t make it easy on your already stretched budget. When you use a cash advance from one creditor to pay the balance on another credit card, you have not really paid off that balance, you have merely moved it to the card on which the checks you have been sent have been written. In addition, you must beware because, while many cash advance offers come with attractive low finance rates, these low rates are usually only in effect for a temporary period of time.
And, as is the case with most discount finance rates, if you miss a payment or are even late with a payment, you may very well find that your finance rate skyrockets up making the card you have just moved your money to even more expensive than the card you originally owed upon!
Many credit card companies use attractive offers of low finance rates on balance transfers and cash advances as means of attracting new customers to their cards. They can afford to offer these reduced finances rates on balance transfers because they expect that most people will use this account for new purchases in the future. No credit card sends you money for nothing. Between new purchases and eventually rising interest rates, fees, and finance charges, with these methods you’ll soon be paying sending your new credit card company the same monthly check you were sending to the company you “paid off”. And, if you’re still using that previous card, as well…well, you do the math.
“Neither a Borrower nor a Lender Be…”
A personal loan might be obtained from a from a friend or family member in an effort to pay off existing debt. However, as they say “nothing spoils a good friendship like conflicts over money.” The risks to your friendships and valued family relationships when you borrow money from someone close to you are obvious. How would you feel if your friend or relative borrowed money from you and couldn’t pay it back? Personal loans from a bank of course, involve more formal agreements. However, while a personal loan obtained from a bank can usually be used for any purpose including consolidating your debt, the interest rates banks typically charge for these loans make them unattractive.
Debt consolidation loans obtained from either your bank or from a professional lending agency may seem to bring welcome relief. But, that relief is likely to be short lived. Keep in mind that, like the credit card maneuvers described above, each of these methods involves the accumulation of new debt to pay off old debt. And, you may have this new debt for a long time to come.
Don’t Bet the Farm! Don’t Trade Unsecured Debt for Secured Debt
Home equity loans and lines of credit may very well be available at extremely attractive rates. In addition, these types of loans allow you to amortize or spread out the payments on your debt over a relatively long period of time. Your bank may even try and entice you to take out this type of loan based upon the promise that the interest on these loans is tax deductible. This may be true, but, your tax deduction is likely to be only a small percentage of the total interest you will pay on the loan. And, since you will be paying that interest over a very long period of time, in effect you will be paying off your current debts for possibly decades to come.
Most importantly, when you take a home equity loan or should you refinance to consolidate your credit card debt, you have now turned unsecured debt into secured debt. That is, because these types of loans involve your bank placing a lien on your home. You have now placed your home at risk as collateral against your loan.
Your Retirement Fund is for Retirement
More and more consumers are also choosing to “borrow” from their own 401k retirement savings to pay off their current debts. This is another so called debt elimination strategy that we must advise against. Usually this strategy is taken based on faulty information or misunderstanding of the way pre-tax retirement funds work.. For one thing, there is an assumption that because you are merely “borrowing” this money, rather than withdrawing it, there is no penalty involved.
True, taking a loan from your own retirement savings will not cost you a specific percentage rate penalty. However, you put that hard earned money away years before your retirement in order to let one of the most reliable financial factors work for you: time! Over a brief period of time, your investments may rise and fall, but, over the long run the savings you leave in your retirement fund are apt to grow considerably and be there when you most need it. Yes, its your money. But, the money you take back and use today to pay off your debt will not be available to work for you.
Assuming you pay yourself back in full, it may take you a number of years to put back money that was already safely secured away and you can’t put back the time and growth that money might have paid off for you had you left it alone. By the way, remember that even though you have borrowed “against” your own retirement savings, that money really belongs to the general fund in which you are a contributing member. Therefore, you cannot simply walk away from this loan without incurring a substantial penalty. And if you stop working at the company where you made your initial contribution due to job loss or retirement, you still must pay back the amount of money you borrowed from the fund. It’sa particularly risky move for anyone who is approaching retirement age and for anyone who’s job security is less than fool proof.
There Has to be a Better Way to Eliminate Debt
There is. It’s a simple, systematic method that won’t sink you deeper into debt. And, using this method, you can get rid of all your debt without increasing the payments you are already making to your creditors each month. It’s called the debt roll-down method.
The debt roll-down method is a great strategy for paying off any debt, including car loans and even your home mortgage. But, let’s look at it first for paying off those credit card debts that you did not place into your debt settlement program, perhaps because the balances on these loans did not seem so overwhelming.
In using the debt roll-down method, first, make a list of all the various credit card debts you are seeking to pay off. Stack these debts, on paper, from lowest to highest according to balance or according to interest rate charged. Determine the debt that you would most like to eliminate first. This is usually the credit card that is currently costing you the most in finance charges and fees.
Using debt roll-down, you will make minimum payments on all your debts except the card you have determined to be your most expensive according to balance or interest rate. You will send this creditor alone an “extra” payment until this initial debt is paid off while still keeping up just the minimum payments on your other cards. As soon as this first card is eliminated, add the total payment amount you were sending to the card that has been paid off to the minimum you havebeen sending to your next most expensive card. Keep making these larger payments to your second creditor until that card is paid off and so on down the line until all your debts are gone. In this way, you will systematically eliminate all your credit card debts, one at a time. And, because you are recycling money from credit cards that you have already paid off to add to your other minimum payments, you will do this without ever adding to the total amount of money you spend each month on credit card debt.
When all your cards are gone, the money you have been sending to your creditors each month is yours to keep! That is, it can be deposited into your own account as savings.
There’s nothing revolutionary here in the debt roll-down method. Although, it’s common sense, it’s not common practice. That’s because most people start “spending” the amount they feel they are saving when they eliminate a debt rather than transfer” that payment from a card that is paid off to a card that you have merely been holding the line on by making minimum payments. The whole system is elegant but relies upon your being sufficiently disciplined to stop using the credit cards that you have enrolled in your roll-down ladder. If you re-open the cards that you have eliminated or continue to use the cards you are paying the minimums on, then the roll-down method will be ineffective. You’ll open a bottomless pit that you will be unable to fill without dramatically increasing your monthly payments to catch up.
Don’t Forget Your “Emergency Fund”
Of course, the debt roll-down method takes some time to complete. It’s not a quick fix solution but, then it doesn’t leave you with any debt either. During the time that you are eliminating your debt, time and events do not stand still. Lots of unpredictable things happen, like car repairs and leaky roofs and unfortunate things like medical expenses you cannot always anticipate.
That’s why it is important that any debt elimination plan you use include a plan to build up your “emergency fund” of savings.
This type of savings cannot wait until you are completely out of debt. Without an “emergency” cash savings fund, falling further into debt even as you are trying to climb out of it is as inevitable as your next unexpected repair bill. Rather than rely upon credit cards to help cover you in a crunch, establishing and maintaining your own emergency reserve fund of cash may enable you to cope without accumulating new debt. And, that’s what this is all about, eliminating debt.
The mistake most people make is to use all their available cash to add to their minimum payments to pay down their debt as quickly as possible (or, so they think). In reality without an emergency fund to back them up, the credit card cycle will continue indefinitely. In the meantime, the car breaks down and the repairs cost $ 300.00. Without money on reserve for emergencies the only option available is to borrow the money or more likely charge the repair to one the very cards you are trying to pay off. Now the balance on the card is higher than the amount reduced by the $25.00 paid every month.
The best way to get a reality check is to compare your credit card bills from month to month. How much does the balance really go down on these small payments? Not much we think. It is wiser to save the $100.00 per month until such time there is a minimum of 1 to 2 months and preferably 3 to 6 months worth of living expenses on reserve. Once that goal has been accomplished, then it would be a good time to think about reducing debt.
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