Possible Wrong Ways to Pay Off Debt

Wrong Ways to Pay off Debt

Paying off debt is a common goal that many Americans have. The burden of high debt is often very stressful and frustrating, and some people are willing to do just about anything to get out of debt.

Although they may seem like a good idea at the time, some ways to pay off debt aren’t always the smartest move for everyone. If you’re considering any of the following ways to pay off debt, you may want to reconsider. These could actual make your debt situation worse in the long run.

Debt Consolidation

A debt consolidation loan may seem like a great way to pay off debt to most people. It gets multiple creditors off your back, and gives you only one payment to make each month. However, there are downsides to some debt consolidation loans.

First off all, you don’t actually “pay off debt” with a debt consolidation loan. Instead you simply trade several small debts for one large debt. And, like any other debt, a consolidation loan still needs to be paid off, often with much higher monthly payments. There’s a chance that you may not be able to afford the monthly payments of a debt consolidation loan, which could end up blemishing your credit with late payments.

When It Might Work: If you’re still considering a debt consolidation loan, make sure that the interest rate you’re offered is lower than the average interest rate you’re paying on all of the debts you want to consolidate. Also, make sure that you can afford the monthly payments with a little wiggle room.

Home Equity Loans

Using a home equity line of credit or a second mortgage to pay off debt is similar to using a debt consolidation loan to pay off debt. The main difference here is that you’re basically putting your home on the line.

While it will usually come with a much lower interest rate, using your home’s equity to pay off debt is actually a little scary, at least to me. If you’re having trouble paying your debts now, you end up with bed marks on your credit report and a lower credit score. If you decide to pay off debt using your home’s equity, however, you risk losing your home if you can’t make the loan payments. To that, I say “yikes!”

When It Might Work: Only use your home’s equity to pay off debt if you’re positive that you can make your payments every month. You must be completely financially secure and responsible enough not to wrack up even more debt.

Borrowing Money From Friends or Family

Although it might be tempting to accept a loan from a friend or family member, this is not usually a good way to pay off debt. Even if you have the best intentions and truly mean to pay the loan back, that doesn’t always happen. Unforeseen circumstances could prevent you from repaying the loan in a timely fashion or even repaying the debt at all. If that happens, things could get very uncomfortable between you and the lender.

When It Might Work: If borrowing money from a friend or family member is one of your only options, proceed with caution. Make sure that you can pay the loan back in a reasonable amount of time and set up a monthly payment plan.

Dipping Into Retirement Funds

If you’ve been working for several years, you might be able to borrow from your retirement funds in order to pay off debt. As tempting as it may be, you should refrain from doing this.

When you borrow money from a retirement account like a 401K, you still have to pay that money back. Some employers will also take the money out of your paycheck in order to repay the loan, meaning that you’ll get less money each pay period. You could also face penalties and early withdrawal fees, especially if you leave your job before the loan is repaid. Also, by borrowing from a 401K, you’re removing money that could be potentially earning even more money for your retirement through investments, like stocks and bonds, and you may not be able to contribute any additional money to the account until your debt is paid off.

When It Might Work: Don’t completely discount borrowing from retirement to pay off debt. If you have a separate savings account set up for retirement, for instance, it might be a good idea to pay off your debt with this money. Just be sure to pay yourself back over time. If you have a 401K or similar retirement account through your employer, make sure you’re satisfied with the terms of the loan before you sign on the dotted line. Also, make sure that your job is completely secure before borrowing from your retirement account.

Debt Settlement Companies

You might be toying with the idea of having a debt settlement company help you pay off debt. Like the other methods of paying debt on this list, this may not be a wise idea. In fact, it could be one of the worst ways to pay off debt.

When you work with a debt settlement company, you will typically be asked to stop communicating with your creditors and even stop sending them payments. The settlement company will then negotiate (or “settle”) your debts for less than you owe, and you will then be required to deposit money into a special account each month to pay your creditors. Sounds simple and appealing, but it often doesn’t work out well for the consumer in the end.

First of all, not paying your debts – like most settlement companies advise you to do – will place several negative marks on your credit report. There’s also no guarantees that a creditor will agree to a settlement company’s offer in the first place. This means that you might still owe the full amount of your debt, and be quite far behind in your payments. Finally, settlement companies typically charge outrageous fees, and most people quickly find that they are unable to afford the large monthly payments.

When It Might Work: Using a debt settlement company to pay off debt is rarely a good idea. However, if you are positive that you will be able to make the monthly payments and your debts are settled for much less than you owe, you might try a debt settlement company if you’re out of options, besides bankruptcy, which should only be used as a completely last resort. Before you do, though, make sure you read this confession from a former debt settlement employee.

Remember that what works for one person may not work for another. If you’re considering one of these methods to pay off debt, it doesn’t necessarily mean that it’s the wrong choice for you. Before doing so, though, make sure you carefully weigh your options and are aware of any possible negative repercussions.

In the end, it all boils down to what works best for you and your personal financial situation.

Did you successfully pay off debt? What advice would you give, and what methods did you use?