Sooner or later you must come to terms with your outstanding debt problems. The consequences of not repaying your debts are dismal — it’s possible you could lose assets such as your home or car. Your ability to borrow again might be limited due to a bad credit rating. Your earnings could be garnished or you could even wind up in court. Not a happy situation.
The good news is that there are a number of debt reduction strategies that can help you pay off debt, reduce financial distress, manage your money better, and improve relationships with creditors. Here are ten of them:
Contact Your Creditors At Once
This is one of the most overlooked ways to resolve your debt problems. Don’t wait for your accounts to be turned over to a debt collector. Communicate with your creditors and assure them you will continue making payments. They are most likely willing to work with you. Be honest and explain your financial situation. Tell them you plan to pay off your debts as soon as possible. Ask for a reduced payment schedule or a lower interest rate. Some creditors might even be willing to accept interest-only payments for a few months. It never hurts to ask.
“If you think nobody cares if you’re alive, try missing a couple of car payments.” -Earl Wilson
Empty Your Savings Account
Do What? If this advice comes as a surprise to you, please try and understand that it makes absolutely no sense to have money in the bank earning only 4% while you’re carrying credit card debts that charge in excess of 18%. Paying off high-interest cards like these is like finding an investment that yields an 18% return, all tax-free and without risk. Even if you’re a stock market guru, your investment returns would actually have to beat 18% because of the tax consequences. If the interest rate on your debts are even higher, the decision to repay versus invest becomes more obvious.
Your asking me to deplete my emergency fund? There are two schools of thought to this question. You may want to leave a small cushion in your account to absorb any unforeseen expenses or temporary loss of income. On the other hand, if you truly need them, you may decide to use your credit cards for an emergency situation. Otherwise use some of the other strategies that follow (borrow from your family,etc).
Increase Your Minimum Payments
Consider this. If you only made the minimum payment on a $2,000 credit bill with an 18% interest rate, it would take you roughly 18 years to pay it off. The interest alone would amount to $3,690. Have you ever wondered why the minimum payment on your credit bill is so affordable? Take a hard look at that last number and you’ll see why lenders set your minimum payment so low (often 2-3% of the outstanding balance). Doubling or even tripling your minimum payments will have a significant impact on your ability to reduce debt. Those increased dollars will save you thousands in interest payments and shave months, if not years, off your debt. Don’t play by their rules.
Pay Off The Highest Rates First
Paying off the highest interest rate rather than the highest balance will result in quicker debt reduction. Your debts may take many years to pay off, so don’t allow the additional interest charges that are still accruing to be at the highest rate. Pay the minimum to each creditor and apply all your remaining money to the debt that has the highest rate. Once the debt is paid off, move to the next highest rate and apply the rollover amount from your first debt. Continue down the list to the next-highest creditor and repeat this process until your debts are gone. Stick with your plan.
Transfer Debt To A Low-Interest Card
If your low-interest card hasn’t been maxed out, and your creditor allows, you should consider transferring all your high-interest debt to it. This strategy won’t eliminate your debt, but it can lower your costs. Call the bank that issues your card and ask for a lower rate. Tell them another company has offered you a better rate with no annual fee. You will be surprised at what your lender will do to keep your business.
Another alternative is to take advantage of the introductory rates many card issuers offer to get you to switch credit cards. We’ve all seen the rates that start out at 5.9%. This temporary solution may save you a few bucks in interest and allow you to pay down more principal each month.
A word of caution: Read the fine print before you act. Many of these “teaser rates” last only a few months. After that, the rate may rise dramatically, even exceeding the rate you’re currently paying. The terms of your card may also stipulate that the low rate applies only to new purchases, not existing balances and that it is valid only to account balances kept for at least a 12-month period. Be careful how you execute this strategy to pay off debt.
Borrow From Family Or Friends
Borrowing from your family or friends is worth considering. After all, they know you, trust you, and probably understand your financial situation better than anyone else. They might even cut you a favorable interest rate or repayment plan. Make sure you put the agreement in writing and that all parties involved understand the terms and conditions of the loan. Keep this part of the relationship professional.
Some alternatives to help solidify the deal:
1) Call the loan an early inheritance and make sure your siblings fully understand your financial situation so they don’t get upset.
2) Split the difference. Pay them an interest rate that is less than what you’re currently paying but considerably higher than what they would earn in a liquid account.
“Some debts are fun when you are acquiring them, but none are fun when you set about retiring them.” -Ogden Nash
Another effective way to find money and pay debts is to reduce your expenses. Is it possible that what you consider a necessity are really optional? There are a variety of things you can do in your daily life that can produce big savings. Here are some simple suggestions:
- Pack your own lunch for work
- Buy generic brands
- Buy secondhand clothing or furniture
- Cancel your health club membership
- Clip coupons
- Cancel your cable service
- Read books, magazines, and newspapers at the library instead of buying them
- Carpool to and from work or school
- Skip the latte or candy bar
- Rent movies instead of going to the theater and buying those expensive goodies
Obtain A Home Equity Loan
If you own a home and have accumulated equity throughout the years, you might consider a home equity loan, also called a second mortgage. Many lenders allow you to borrow against a certain percentage (usually 80%) of the equity in your home. For example, if you owed $50,000 on a house that was appraised at $150,000, your equity would be $100,000 ($150,000 – $50,000). You’d be able to borrow up to $80,000, or 80% of $100,000.
You can use this type of loan to pay off all your outstanding debts and start paying only one monthly payment at a lower interest rate. The interest on home equity loans is generally tax-deductible if you itemize on your income tax return. You’re effectively getting one of the cheapest rates for personal consumer debt.
This type of debt consolidation is not for everyone however. It only works if you stay disciplined and avoid charging up your cards again. The last thing you want to do is have credit card bills to pay on top of the home equity loan payments you’ve just established.
Borrow From Your 401(k)
Check the literature of your employer’s retirement plan to see if you can borrow against your 401(k) balance. Most plans allow you to borrow up to 50% of the account’s value of $50,000, whichever is lower. In most cases, you’ll have up to five years to pay the loan amount back and the interest rates are reasonably less than credit card rates. The good news: you not only borrow from your account but the interest you pay also goes back into your account, not the lender’s.
Before you pursue this strategy, take a look at a few of the disadvantages:
You lose the earning potential of the money you borrowed.
The interest that you pay on the loan is deducted from your paycheck with after-tax dollars. The interest will also be taxed again when you withdraw money from your 401(k).
If you leave your employer before your loan is repayed, the entire balance on the loan may be due in a short period of time. The balance of the loan will be reported as a distribution to you and will be taxed as ordinary income. If you’re under 59-1/2 you will be subject to a 10% early withdrawal penalty as well.
“The only man who sticks closer to you in adversity than a friend is a creditor.” -Unknown
Talk To A Credit Counselor
If you feel you can’t negotiate with creditors on your own or your debts are just getting out of control, there are many credit counseling services out there that can help you. One of the best known is the National Foundation for Consumer Credit (NFCC). The NFCC is a network comprised of 1450 non-profit community organizations (most use the name Consumer Credit Counseling Services or CCCS) spread across the United States.
Certified counselors at CCCS will examine your financial situation, help you develop a spending plan, or just answer general questions about money management. If you have severe debt and your situation warrants, you may be able to enroll in their Debt Management Plan (DMP). In this plan, you agree to deposit funds into a CCCS account each month. CCCS distributes payments to creditors according to the proportion of debt owed to each. They also contact your creditors to ask for lower interest rates, lower monthly payments, and waived finance charges. It will take approximately 48 months to repay debts through the DMP and when you have completed your payments, CCCS will help you re-establish credit.
A few things you should know when dealing with CCCS:
CCCS is funded with voluntary contributions from creditors.
Up to 15% of your DMP payments to creditors will come back as voluntary contributions to CCCS. Your accounts with creditors, however, will always show 100% payment.
CCCS and your creditors will discuss many options but they’ll never mention bankruptcy as one of them.
If you enroll in the Debt Repayment Plan from CCCS, make sure you follow through. Missed payments or reluctancy to keep up with the plan may show up on your credit report as an uncollected debt. Not good.
If there are no CCCSs in your area, the NFCC recommends asking the following questions to help choose a qualified credit counseling service:
- Is this agency a non-profit organization?
- How much will these services cost?
- Are agency services confidential?
- What counseling services are offered?
- Are the counselors qualified?
- Are budget and credit education opportunities offered?
- Will my funds be protected?
- Is the agency accredited?
- If your debts are too high to make the CCCS plan work or you’ve exhausted all other options, then you may want to explore bankruptcy as a last resort.
To contact the NFCC:
National Foundation for Consumer Credit
8611 Second Avenue (Suite 100)
Silver Spring, MD 20910
1-800-388-2227 (24hr automated listings)
Or look under “Credit and Debt Counseling” in the business pages of your local telephone directory. The NFCC also has a member office locator at it’s web site that will allow you to find the NFCC member organization nearest you.
Stay clear of credit repair agencies, clinics, or debt doctors who claim they’ll fix your bad credit rating. For a large fee, they promise to remove negative credit information from your file or create a new credit history for you. Legally, this is not possible. They are a scam, so move on. The only way to re-establish your credit are time and an improved credit record. There are no quick fixes. No magic tricks.