The 7 Best Ways to Get Out of Debt
Seven of the best ways to get out of debt include temporarily ceasing contributions to a retirement account, consolidating your debt, borrowing against a life insurance policy, and getting a home equity loan.Temporarily Stop Contributing to Your Retirement Account
One way to get out of debt is to stop paying contributions to a retirement account – at least until you get out of debt. You can then use the extra money to pay off a credit card. The interest you're paying on your credit card debt more than likely outweighs any returns that you realize from monthly retirement contributions. It is important, however, to begin contributions to the account again once you have cleared the debt.Pay More Than the Minimum
Paying only the minimum on your credit card balance, typically 2 to 3% of the outstanding balance, prolongs your debt. The longer it takes you to repay your balance, the more interest the credit card company earns.
It is much more beneficial to pay the maximum amount that is feasible. If the minimum required monthly payment is $75, double or triple it if possible, or at least make a payment of $100. This may require you to cut back on expenses, but in all likelihood, some of those expenses contributed to amassing the debt in the first place. The increased monthly payments will save hundreds or thousands of dollars that you're paying in interest fees, and it will decrease your debt level at a much more rapid pace.Consolidate Your Debt Payments
Examine all of your credit cards, and focus on the card that has the lowest interest rate. Consider transferring your higher-interest bills to this card. Several credit cards allow you to do this. You can spend less and pay down debt quicker by trading debt at 16% interest for debt at 11% interest.
If the entire balance of the debt will not fit on one lower-interest card, pay at least the minimum on every card except one, on which you can concentrate extra payments. Pay off the balance on this card in the least amount of time possible. Once you have completely paid off the card, take the same approach with each remaining card. This is known as a debt snowballing.Borrowing Against Life Insurance
If you have a life insurance policy with cash value, you can borrow against the policy. You are essentially only borrowing money from yourself. This represents an advantageous interest rate tradeoff, since the interest rate on such a loan is likely to be substantially lower than commercial interest rates.
You can take your time in repaying the insurance loan, but it is important to repay the loan. If you die before repaying the loan, the outstanding balance plus interest is subtracted from the value of the policy, thus decreasing the amount paid to the beneficiary. While this seems inconsequential when you're under burdensome debt now, it could pose significant financial problems for your beneficiary later.Home Equity
If you're a homeowner and you have built up equity by paying off your mortgage, a home-equity loan line of credit is another option. Using this loan's proceeds to pay down debt typically allows you to cut your interest rates in half. If you itemize deductions on your income tax returns, the interest on a home equity loan is typically a deductible item, which reduces your actual cost of borrowing. Use the home equity loan to pay off your credit cards, and then keep them paid off until you have repaid the loan. Otherwise, you may risk falling into even more debt.401(k) Loan
Borrowing from a 401(k) is also an option, provided that it qualifies. Most 401(k) plans are equipped with a feature that lets you borrow a maximum of 50% of your account's vested value, or $50,000, whichever value is less. With interest rates that may be only a bit above the prime rate, this makes a 401(k) loan cheaper than credit card interest rates. The other bonus to this option is that every penny that you pay in interest goes directly back into your 401(k) account. In effect, you're paying yourself back the interest charged on the loan.
There are some negatives to utilizing this option, however. You are repaying the loan and the interest with after-tax income, and the interest is taxed again when you cash the 401(k) out upon retirement. Also, you must repay the loan within five years. If you leave your place of employment before fully repaying the loan, the remaining balance is due immediately. If you do not repay it within 60 days from that point in time, the amount is treated as a distribution to you and is taxed at regular rates. In addition, if you are under 59.5, a 10% excise tax is also taken as a penalty for early withdrawal.Bankruptcy
If your debt has reached a totally unmanageable level and you simply cannot pay it down, your last resort is to file for bankruptcy. There are two kinds of personal bankruptcy: Chapter 7 and Chapter 13.
Chapter 7 is straight bankruptcy that relieves you of almost all of your debts. Some forms of debt that are not relieved include child support, taxes and student loans. Chapter 7 also typically requires you to surrender a large portion of your property to satisfy the debt; states have different laws that provide exceptions, including low-value vehicles, tools used for business and certain amounts of equity in a home.
Chapter 13 allows you to keep your property, but it does require you to surrender all control of your finances to the court. The bankruptcy court approves a repayment plan based on your res, allowing for the repayment of part or all of your debt over a period of three to five years. Creditors are prohibited from harassing you for repayment during this time. Also, the debt does not accrue interest charges during this period.
Bankruptcy is a last resort because of the serious drawbacks involved. You must pay for court filing fees and attorney costs to file for bankruptcy. Laws have become more rigid, so you may not qualify for complete relief of your debts. Your credit record will display bankruptcy information for 10 years, which can damage to potential employment opportunities and almost completely ensure that you cannot obtain affordable credit during that time frame.