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.
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.
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.