How to Pay Off Debt

In the previous article about credit card debt, you learned the method for tackling this nefarious problem. But now that you know how to approach this financial dilema, you may be wondering, “Where will I get the money to do this?”

Here are some tips from The Motley Fool to help you find the funds to pay off your credit card debts. And don’t forget to visit their web site for more great advice on managing your finances.

1. Pay more than the minimum

The longer you take to repay the charges, the more interest the banks make, and the less cash you have in your pocket.

Instead, take the plunge and pay as much as you possibly can each month. If your minimum payment is $100, double that to $200 or more. Examine your normal expenses – you can find the money. Don’t eat out at lunch; bring it from home instead. Eliminate desserts and happy hour. We all have “luxuries” – find yours and tame them.

A few extra dollars every day can increase your debt repayments dramatically, which will in turn save you hundreds, if not thousands, in interest payments.

2. Snowball your debt payments

If you haven’t reached the maximum limit on your lowest-rate credit card, consider transferring a higher interest bill to that one. If all of your credit card debt is too large to fit on one low-interest rate card, pay the minimum amounts due on all of your cards except one. Funnel the majority of your debt repayments into that one card and pay it off as quickly as possible. When the balance on that card is eliminated, move on to the next with the same aggressive repayment plan.

Continue this strategy of snowballing your payments until all your credit cards are paid off. As your debts decrease, the amount of money you have to pay them increases. Your payments snowball until all your debt disappears, much to your joy and astonishment.

Another consideration is to take advantage of the promotional offers banks use to entice you to their line of credit. It could be worth it. Moving to 5.9% from 18% interest could mean substantial dollars to you. And the money saved in interest could then be applied toward the principal each month, thus reducing your outstanding debt balance even further. Just make sure you read the fine print – some financial institutions penalize “card-hoppers.” If you transfer balances from the new card within 12 months of activation, the normal interest rate may be applied retroactively. Know your terms before you sign up.

3. Cash out your savings account

Another option is to cash out your savings and investments and use the cash to get out of debt. Most people don’t like the thought of doing that, but even when debt interest is at 12%, your investments would have to pay more than 18% (before federal and state taxes) to equal that outflow of dollars. Your savings account probably isn’t earning anywhere near that rate of interest (if it is, let me know, I’ll change banks today!). Pay off the debt, and it’s just like getting that 18% return without any risk on your part. The higher the interest rate on your debt, the more attractive repayment versus investment becomes.

4. Borrow against your life insurance

If you have life insurance with a cash value you can borrow against the policy. That’s right, you’re borrowing from yourself. But the interest rate is typically much lower than commercial rates, and you can take your time repaying the loan. Just don’t die before it’s repaid – the outstanding balance plus interest will be deducted from the face value of the policy payable to the beneficiary.

5. Finagle family and friends

You’re treading on potentially dangerous ground here, but for some people this is a legitimate strategy. Know one else knows, trusts, and loves you like family and friends, and you’ll most likely get a very favorable interest rate. But if you want to maintain the relationship, establish the interest and repayment schedule in a written agreement to avoid misunderstandings and hard feelings.

6. Get a home equity loan

If you own your own home and have some equity that’s accumulated through the years as you’ve paid off the mortgage, now’s the time to consider a home equity loan (HEL) line of credit for the maximum amount possible.
First, you use the proceeds to pay down your debt, trading something like an 18% loan for a 9% loan. Second, most homeowners itemize on their income tax returns. HEL interest under most circumstances is a deductible item. In a 28% marginal tax bracket, the 9% loan really has an effective rate of 6.5%, and that’s probably the cheapest interest rate you’ll see on personal indebtedness.

But don’t fall into a common trap. Many get an HEL, pay off existing debt, and then get into trouble with the credit cards all over again. Now they have the HEL to repay on top of the credit cards. The hole just got much deeper. Use the HEL to pay off the credit cards, and then keep them paid off until the HEL is repaid.

7. Borrow from your 401(k)

Most 401(k) plans have a loan feature that lets you borrow up to 50% of the account’s value, or $50,000, whichever is smaller. Interest rates are usually one or two points above prime, which is usually cheaper than that found on credit cards. And the best part is that you pay it to yourself. Every penny in interest paid on a 401(k) loan goes directly into your 401(k) account, not the lender’s.

However, there are some drawbacks. First, the loan and interest will be repaid with after-tax dollars, and the interest will be taxed again when you finally withdraw money from the 401(k) years later. Also, you must repay the loan in five years or less. If you leave your employment before paying in full, the outstanding balance becomes due and payable immediately. If not repaid, that amount will be treated as a distribution to you. You’ll be taxed on that amount at ordinary rates. And if you’re under the age of 59 1/2, you will also be assessed an additional 10% excise tax as a penalty for an early withdrawal of retirement funds. So make sure that any 401(k) loan can be repaid before you leave your job.

8. Renegotiate terms with your creditors

OK, you’ve done all you can. Savings are gone; relatives have been tapped out; you don’t have a home or 401(k) to borrow against. But before you go down the thorny path of bankruptcy, there’s one more trick to try. The threat of bankruptcy.

Tell your creditors your situation. Let them know that if you are unable to renegotiate terms, then you’ll have to declare bankruptcy. Ask for a new and lower repayment schedule; request a lower interest rate; appeal to their desire to receive payment. Faced with the prospect of a total loss, creditors will do what they can to protect themselves. And if you don’t think you can negotiate yourself, debt triage organizations exist that can do it for you.

9. As a last resort, file bankruptcy

You have a moral obligation to repay your debts to the utmost of your ability. There are times, however, when repayment may be impossible. In those cases, bankruptcy may be the only available course of action. But keep in mind that such an action carries significant drawbacks.

Your credit record will contain this information for 10 years, meaning you will have a difficult time obtaining credit you can afford during that period. Also, ironically, it costs money to file for bankruptcy. Attorney and court filing fees cost in the hundreds of dollars.

There are two types of personal bankruptcy relief: Chapter 7 and Chapter 13. Chapter 7 is straight bankruptcy that allows the discharge of almost all debts with the exceptions of alimony, child support, taxes, loans obtained through filing false financial statements, loans not listed in the bankruptcy petition, legal judgments against the petitioner, and student loans. You may also have to surrender much of the property you own to help satisfy the debt. Typically, though, you may usually keep your car, tools of your trade, your home, and most personal property.

With Chapter 13 bankruptcy, you keep your property but give up control of your finances to the bankruptcy court, which approves a repayment plan – based on your resources – that provides for repayment of all or part of your debt over a period of 3 – 5 years. During that time, your creditors may not harass you for repayment and you incur no interest charges on the indebtedness. When all conditions of the court-approved plan have been satisfied, you emerge debt-free from the bankruptcy.

A local bankruptcy attorney can help you understand the differences between Chapter 7 bankruptcy and Chapter 13 bankruptcy, so that you can make an educated decision about the best next step for you. Fill out the form below for a free bankruptcy case evaluation by a local attorney.