You can throw the reminders in the Cuisinart
or chuck them into a garbage can, but that won't make the debt
go away. Debt hovers like a carrion bird over a dying beast,
costing you more than 18% compounded monthly, month in and month
out. You can't wish it away. But you can pay it down with determination,
our free How To Get Out of Debt online guide, and the good graces
of a few wealthy relatives (see tip No. 5). Here are nine ways
to get out of debt:
1. Pay more than the minimum
First, break the habit of only paying the minimum
required each month. Paying the minimum -- usually 2% to 3%
of the outstanding balance -- only prolongs the agony. Besides,
it's precisely what the banks want you to do. The longer you
take to repay the charges, the more interest they make, and
the less cash you have in your pocket. Don't play their selfish
Instead, bite the bullet and pay as much as you can each month.
If your minimum payment is $100, double that to $200 or more.
Examine your normal expenses -- you can find the money. (For
a gazillion ideas, check out our Living Below Your Means discussion
board.) Skip eating out at lunch, and bring it from home instead.
Eliminate desserts. Give up happy hour. We all have "luxuries,"
and you know what yours are.
Make a few sacrifices, and you will find the extra dollars needed
to increase your debt repayments dramatically. Those increased
payments will save you hundreds, if not thousands, in interest
payments. Plus, you will get out of the hole you've dug for
yourself much more quickly. Is it fun? No. But it sure beats
living a hand-to-mouth existence, fearing bills each month.
2. Snowball your debt payments
Take a long, hard look at all your credit cards.
Pay particular attention to the one with the lowest interest
rate. Have you reached the maximum limit on that card? If not,
consider transferring a higher interest bill to that one. Many
credit cards permit this, and it's positively Foolish to trade
an 18% debt for one at 12% at any time.
If your entire balance is too large to fit on
one low-interest rate card, pay at least the minimum amounts
due on all of your cards except one. Funnel the majority of
your debt repayments into that one credit card, and pay it off
as quickly as possible. When the balance on that card reaches
zero, move on to the next with the same aggressive repayment
Lather, rinse, and repeat. This method of snowballing
your payments is aptly called "snowballing." As your
debts decrease, the amount of money you have to attack them
increases. Your payments snowball until all of your debt is
pummeled. Pretty neat, eh?
Another way to transfer higher interest debt
to a lower-interest card is to take advantage of the promotional
offers many banks use to entice you to their line of credit.
You've seen the come-ons. "Transfer all your credit card
balances to us, and pay just 5.9% until January 1, 2003."
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. (For more
on how to take advantage of balance-transfer offers, head to
step 2 of our free How To Get Out of Debt online guide.)
Take care, though, before you act. Examine the
offer closely. Look for the hooks. Will the interest rate after
the introductory period be higher than you're paying now? If
so, you may have to switch again at that time. That, in turn,
could give rise to another surprise. Banks have caught on to
the charge card hoppers who switch from card to card to take
advantage of the low introductory rates. Many of these offers
now stipulate that if you transfer balances from the new card
within a 12-month period, the normal interest rate will be applied
to all outstanding balances retroactively. That proviso could
be a bitter pill to swallow for someone short on cash, and it
certainly doesn't help the debt repayment schedule. Read the
fine print, Fool.
3. Cash out your savings account
You could cash out your savings and investments
and use the proceeds toward debt repayment. Yeah, no one wants
to do that. But sometimes it's just Foolish to do so. 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. We doubt the dollars in your savings account are
earning anywhere near that rate of interest. Pay off the debt,
and it's the same as 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
Do you have life insurance with a cash value?
If so, borrow against the policy. Yes, you're borrowing your
own money. But the interest rate is typically well below commercial
rates, and you can take your time repaying the loan. Do repay
it, though. If you die before it's repaid, the outstanding balance
plus interest will be deducted from the face value of the policy
payable to the beneficiary. As a negative, that seems a small
price to pay to get out of debt now, but it could be burdensome
to your family or loved ones should you sleep the eternal sleep
before paying it back.
5. Finagle family and friends
Perhaps your family or friends could help through
a loan. Who else knows, trusts, and loves you like they do?
Unless you're really the black sheep of the flock, chances are
you'll get a very favorable interest rate. They may even tolerate
a late payment or two. But if you want to maintain the relationship,
it's best to keep things on the straight and narrow by using
a written agreement. You should clearly establish the interest
and repayment schedule in writing to avoid misunderstandings
and hard feelings. And it goes without saying that you must
be scrupulous about adhering to that schedule. Otherwise, you
can forget the family reunions and birthday presents.
6. Get a home equity loan
Do you own your own home and have some equity
that's accumulated through the years as you've paid off the
mortgage? If so, now's the time to consider a home equity loan
(HEL) line of credit for the maximum amount possible.
An HEL gives you a double whammy. First, you
use the loan proceeds to pay down your debt, thus 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.
The danger here is falling into a common trap.
Many get an HEL, pay off existing debt, and then ring up the
charges on 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. Fools 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)
Do you participate in a 401(k) qualified retirement
plan at work? 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 a point or two above
prime, which makes them cheaper than that found on credit cards.
Thus, 401(k) plan loans may be a Foolish option to debt repayment.
Not only is the interest typically much lower than that on credit
cards, the best part is you pay it to yourself. That's right,
every dime in interest paid on a 401(k) loan goes directly into
the borrower's 401(k) account, not the lender's. That lessens
the bite even more.
But there are some drawbacks. First, the loan
and interest will be repaid with after-tax dollars, but the
interest will be taxed again when you finally withdraw money
from the 401(k) years later. Additionally, you must repay this
loan in five years or less. If you leave your employment prior
to full repayment, the outstanding balance becomes due and payable
immediately. If it's 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. Accordingly, ensure
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. You feel like you're against that proverbial
wall. The money just isn't there. Is bankruptcy the only way
out? No way. Try pulling that ace out of your sleeve prior to
taking that step. What ace? The threat of bankruptcy ace, of
Let your creditors know your situation. Tell
them that if you are unable to renegotiate terms, then you have
no other recourse except to declare bankruptcy. Ask for a new
and lower repayment schedule; request a lower interest rate;
and appeal to their desire to receive payment. Faced with the
prospect that you may resort to such a drastic step, creditors
will do what they can to protect themselves against a total
Indeed, many will negotiate away the farm before
they'll be willing to write off your debt. As lawyers love to
say, everything is negotiable. Therefore, what do you have to
lose, save time? It's worth a try. And if you don't wish to
do this yourself, organizations exist that can do it for you.
For details, see Step 5 (Debt Triage) in our How To Get Out
of Debt Guide.
9. As a last resort, file bankruptcy
What if you decide you can't pay down your debt
using any of the methods listed above? What should you do? The
absolute last resort is bankruptcy. Within Fooldom, we firmly
believe everyone has a moral obligation to repay their debts
to the utmost of their ability. There are times, though, when
repayment may be impossible. In those cases, bankruptcy may
be the only available course of action. Nevertheless, be aware
of the significant drawbacks.
Your credit record will contain this information
for 10 years, thus ensuring you will have a tough time obtaining
credit you can afford during that period. Additionally, as odd
as it seems, it also costs money to file for bankruptcy. Attorney
and court filing fees cost in the hundreds of dollars, and they
must be paid to obtain the relief sought.
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. Those that aren't
discharged are 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. While Chapter 7 relieves you of the responsibility
of repaying most creditors, you may also have to surrender much
of the property you own to help satisfy the debt. In general,
though, you may usually retain your car, tools of your trade,
your home, and most personal property.
Chapter 13, sometimes called the "wage-earner
plan," is different. You keep your property but surrender
control of your finances to the bankruptcy court. The court
approves a repayment plan based on your financial resources
that provides for repayment of all or part of your debt over
a three-to-five-year period. During that time, your creditors
may not harass you for repayment. You also incur no interest
charges on the indebtedness during the repayment period. When
all conditions of the court-approved plan have been fulfilled,
you emerge debt-free from the bankruptcy.