More often than not, debt and desperation go hand-in-hand. With the amount of strain debt can put on your wallet and your life, it’s no wonder why so many people find themselves searching for quick fixes. Unfortunately, there is no magic wand to make your debt disappear. If you think you’ve found a fast solution to the problem, you may find that you caused more damage than repair — especially if your spending habits tend to get you deeper into debt. So, with that in mind, here are five debt repayment strategies that can backfire on you.
1. Dipping Into Your Retirement Funds
When you are deep in debt, falling back on the money in your 401(k) can be extremely tempting and it’s relatively easy to do. However, this decision comes with potential ramifications. For instance, if you’re not of retirement age, you might have to pay it back and it will come right out of your paycheck, leaving you with less take-home pay. Or, if you don’t have to pay it back, you could end up owing the IRS for income. What that means is that you would have to take out more to cover the taxes or figure out a way to deal with your new creditor — the IRS or your state.
My suggestion is to only use your retirement savings as a last resort. Remind yourself that it took years to build those funds and to use it for unsecured debts is often a mistake. Look at the big picture and try to figure out the underlying issues. If it’s cash flow, then taking these funds will not help fix the problem. Your retirement savings is not an ATM machine, so don’t treat it like one.
2. Borrowing From Friends & Family
Feel those strings pulling on you? That’s the feeling of borrowing from friends or family to pay off debt. Listen, if you can borrow money from them without guilt and the giving party can be nonjudgmental, then give it a shot. More often than not though, borrowing from friends and family will only put stress on, or even destroy, your relationship. If you choose this option, no matter what side you’re on, I always recommend that everything be put in writing so everyone is on the same page.
3. Refinancing or Taking a Reverse Mortgage
If you’re not careful, borrowing against your home’s equity can be a dangerous move. While you might find yourself with a lower interest rate on your debt, you’re turning what was once an unsecured debt into a secured one. This means that if you were to ever find yourself injured or out of a job and unable to make your payments, you may be at risk of losing your home. When it comes down to it, taking out a home equity loan or doing a cash-out refinance only trades one debt for another.
Another way people are looking to pay down debt is to take a reverse mortgage. This is only available to people 62 years and older and has its own set of considerations. There are large fees for reverse mortgages and the process typically results in you passing ownership of your home over to the bank as opposed to your heirs. If you want to keep possession of a home and have more financial peace of mind, downsizing may be a better option for you.
4. Transferring Your Balance to a New Credit Card
Consolidating your debt onto one card to take advantage of a low introductory rate is a common get-out-of-debt strategy, but there are two things you need to keep in mind.
First, those introductory rates are temporary and will go up to a percentage that’s likely higher than you have on your old card. Unless you know you can pay your balance off in full before time runs out, you may want to rethink this tactic. Second, take balance transfer fees into consideration. A high balance transfer fee could wind up costing you just as much, if not more, than the interest you already owe. Consider whether you can take practical approaches to increase your cash flow to put toward your debt instead. This calculator can show you how long it will take to pay off your credit card debt.
5. Filing for Bankruptcy
Most people assume that bankruptcy is an easy way to make all of your debt disappear. However, bankruptcy is a serious decision that will stay on your credit report for up to 10 years and will seriously limit your access to credit in the near future.
Debt isn’t something that can be fixed quickly, but realize that’s a good thing. Getting into debt is an opportunity for you to seriously reconsider how you manage your money and adopt better financial skills. Paying off loans takes time, patience and dedication and the habits you pick up while paying off your debt can help you to avoid it in the future.
If you want to see how your debts are affecting your credit, you can check your annual free credit reports through AnnualCreditReport.com. You can also get a free credit report summary updated every month on Credit.com.
More on Managing Debt:
- How to Pay Off Credit Card Debt
- 5 Tips for Consolidating Credit Card Debt
- The Best Way to Loan Money to Friends & Family