8 Ways You Can Start Reducing Your Debt
Let’s face it: no matter how many times you trash or hide those credit card bills, loan statements, and other billing statements, your debt is not only with you, but accumulating constantly. It’s absurd, but some credit cards will charge you as much as 23% annually on your charges. Furthermore, those percentages are compounded monthly, so you end up owing interest on your interest! I’d qualify credit card interest policies to basic loan sharking.
How can you start reducing your debt today, and with that, your interest payments? Here are 8 ways that really work:
- Pay more than your credit card minimum.
When I pay my credit card bills, I try to pay at least 10% of what I owe. This generally works out to about 10X the minumum required payment on the card. By doing this, I actually reduce next month’s credit card amount.
Keep in mind that, by paying only the minimum amount due on your credit card, you are racking up additional interest for the banks. The banks love this, and have even recently lowered the minimum required payment. After all, who wouldn’t like to loan out $5,000 of their own cash and see a 23% return on it year after year, with compounded interest to boot?
You may think that the minimum amount is all you can manage to pay at this moment, but that simply is not true. There are certain luxuries in your life that you can eliminate in order to come up with the extra cash per month. Cutting down on happy hour outings, taking your own lunch to work, eliminating the morning Starbucks latté- all of these things, when eliminated, can make a significant impact on your cash flow. We all have our spending vices, and you know what yours are.
- Transfer and consolidate your debt.
Take a look at all your credit cards and the interest rates that they charge. Is there a credit card that has a particularly low interest rate? If so, call up that credit card and ask if you can transfer your other credit card amounts to it. Most credit card companies allow transfers. An additional benefit to doing this is that you consolidate your credit card debt to one card, saving you time and even stamps.
If you are not happy with any of your cards and their interest rates, or the lowest interest rate card is maxed out, consider applying for a new 0% APR (annual percentage rate) credit card. Many credit card companies offer 0% APR for 6 months or more on transferred amounts. This will give you a temporary respite from high interest fees, allowing you to save up your cash and hopefully pay off your entire transfer in those 6 months of time.
Be aware, though, that the same 0% APR card you have just transferred your debt to may have a bigger APR than your old card once the 6 months are up. This means that you either have to pay off what you owe in 6 months or find a different card to transfer to.
- Borrow from relatives and friends.
It may one of the wisest financial maneuvers you can make. As long as you haven’t already borrowed from family and friends and defaulted, such a loan should be pretty simple to accomplish. Ensure your relatives and friends that you are a person of your word, and that you can be trusted to repay the loan. If necessary, type up and sign a document stating how much you are borrowing and for how long. Also, to sweeten the deal, offer the borrower some kind of interest rate- say 1-2%. This rate is far below what any lending company or bank will ever give you, and it gives the borrower a little bit of reward for his/her troubles.
- Empty your piggy bank.
Nobody likes to empty a savings account, but sometimes, it’s the best thing to do. Especially now when banks are giving piddly interest rates on savings accounts, does it make sense to be accumulating a 1.5% interest rate on your savings and then be paying 20% on your credit card debt? Yep, didn’t think so. And don’t forget that the interest paid to you by the banks is taxable, so even if you’re earning a whopping 5% on your savings, it’s actually more like 3.5% after taxes.
- Take out a home equity loan.
If you own a home and have some equity built up in it due to past mortgage payments, you may want to consider getting a home equity loan. Especially now, with the economy being what it is, you could obtain a home equity loan for around 6-7% APR. This APR beats out most credit card APRs by at least 10%.
There is another big advantage to obtaining a home equity loan: in most cases, the interest that you pay on it is tax deductible. If you itemize your deductions on your income taxes, then home equity loan interest can be deducted. This means that your interest rate of 6-7% becomes more like 5%.
What you need to assess before taking on a home equity loan is how much it will cost to obtain that loan. If you have a large amount of debt and are paying outrageous interest charges, then a home equity loan is certainly worth it. However, if your total credit card and other debt is under $10,000, it’s best to just suck it up and eat out less often.
- Borrow against your life insurance/401(k).
Neither of these options is the most desirable solution to paying off your debt, but if you don’t have a home, savings, or rich relatives, borrowing against your life insurance and/or your 401(k) may be your only recourse, short of filing for bankruptcy.
Starting with life insurance, you can borrow against your own policy, and the interest rate is well below that of any credit card APR or even a bank’s. After all, it is your own money. Also, repayment times are usually pretty long. Keep in mind, though, that should you die before the policy is fully repaid, the remaining balance will be deducted from the face value of the policy before it is paid to your beneficiary. So, do make sure to repay what you owe- even if you only owe to yourself.
If you have a 401(k) qualified retirement plan, you may borrow up to 50% of your account’s value, or $50,000, whichever is smaller. You will also pay interest on this loan, but it will be significantly smaller than that of credit cards or banks. Also, the interest paid on your loan goes into your own 401(k) ccount, not to the borrower, so in essence it’s an interest-free loan.
Keep in mind that, even though you will be paying off your 401(k) loan with after-tax money, the interest that goes into your account will be taxed again once you withdraw your 401(k) upon retirement. Also, a 401(k) loan must be repaid in 5 years. Should you leave your current employer before you have fully repaid your 401(k), your entire amount is due immediately. If you can’t pay that amount immediately, it will be treated as regular income and taxed, AND you’ll have to pay a 10% excise tax as penalty for early withdrawal. So, tread carefully with a 401(k) loan.
- Have a chat with your creditors.
If you are at wit’s end, tapped out on savings, home equity, and your 401(k), it may be best to file for bankruptcy. However, before you do file, make a call or two to your friendly local creditors. Explain your financial situation to them and ask them for a lower APR on your debts. Negotiate repayment terms. Most creditors will lower your rate and increase your time of repayment in order to avoid a total loss on the money due to them. It’s worth a shot. Alternatively, there are professional organizations that can negotiate on your behalf, if you feel more comfortable taking that approach.
- File for bankruptcy.
The B word may be one of the most dreaded words to all humankind, but if you really can’t pay off your loans and debts, it may be best to wipe the slate clean and start fresh. Keep in mind, though, that bankruptcy will remain on your credit record for 10 years, positively guaranteeing that you’ll have trouble obtaining credit for some time to come. Also, it actually costs money to file for bankruptcy! There are attorney and court costs to consider, after all.
When looking into bankruptcy, it pays to know which types are available: Chapter 7 and Chapter 13. Chapter 7 is the simpler of the two, allowing discharge of almost all debt owed except items such as alimony, child support, student loans, and any loans left out of the bankruptcy filing. You will probably surrender a majority of your assets to at least partially repay your debt. However, most states have laws in place that allow you to retain necessities like your home, a low-cost vehicle, and tools used in your trade or business.
Chapter 13 bankruptcy allows you to keep your property and assets but gives the court control over your finances. The court then decides upon a repayment plan for all or part of your debt, which you will adhere to for the next 3-5 years. The good thing about a court-ordained repayment plan is that you incur no additional interest charges on what you owe. Also, creditors are not allowed to harrass you. And, when the terms of your plan are completed, you are debt-free.
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