It’s never a good time to be in credit card debt, but I’ll be honest: the nasty economic climate makes it an even worse time to be in debt.
Creditors are jacking interest rates and employers are slashing jobs—a combination that could land any of us between a rock and a very hard place. If you haven’t taken action on your unpaid debt yet—or have slipped from your plan—reread these eight fundamental ways to dig out from under your credit card debt.
1. Pay more than the minimum payment
I don’t think going into debt—even credit card debt—is, by itself, a financial sin (if you have a good reason). What is sinful—and dangerous, too—is going into credit card debt and then only paying the minimum monthly payment. No matter what your total credit card payment, if you only pay the minimum every month, it will take you more than 10 years—possibly 20 or 30—to totally pay off your debt. Plus, you’ll have paid your credit card company thousands in interest for the privilege.
If you do nothing else to start digging out from debt, pledge to pay more than you minimum payments. Try to double your payments if you can. If that breaks your budget, look for ways to cut back, and up your minimums as much as you can—even if it’s only be $10 or $25 dollars each.
2. Snowball your credit card payments
Snowballing is about paying down the credit cards with the highest interest rates first as fast as possible, then moving onto the next credit card, and the next. There are dozens of calculators out there to show you how snowballing can work for you, but the premise is simple:
- Determine how much you can pay monthly on your debt
- Determine your highest interest credit card
- Each month, pay all your minimums, then pay the rest on the highest rate card
- When that card is paid off, repeat until all debts are paid
Of course, at any time during your snowball, you get the chance to swap a high rate card for a 0% APR or other low interest rate (see this list of balance transfer credit cards offering 0% APRs for some ideas), do so, and again move your monthly payments to the next card with the highest APR.
3. Cash out your savings
Nobody wants to cash out your savings account to repay credit card debt, but if you have a savings account or investments, you’re one step above those in debt without savings of any kind. If you’re paying 15% or 18% on your credit cards and earning 3% or 5% on your savings, it doesn’t make much sense not to pay down the credit cards. Of course, you’ll be out an emergency fund for a while, but you can save that back up. When it comes to touching retirement accounts like your 401(k) or an IRA, however, think twice: you’ll pay 20% taxes and a 10% early withdrawal penalty to cash out your retirement. In most cases, it’s not even worth doing so to pay down high interest credit card debt.
4. Turn to family
It’s tough to ask family for money, but you may be surprised how willing a loving family member may be to help if you’re sincere. Whenever you turn to family or friends for a loan, however, insist on a written arrangement. Borrowing money from family or friends is risky business if you stop paying,
5. Get a home equity loan
If you own your home, you can tap into the equity you’ve accumulated through years of paying down the principal. (Assuming you’ve owned the home long enough—and in a favorable enough market—to have built up equity).
I recommend a home equity loan (HEL) rather than a home equity line of credit (HELOC) because you won’t be tempted to add new debt on top of the credit card debt you’re already trying to repay. (Also, do NOT use those credit cards again once the balance is transferred to the home equity loan!)
If you qualify for a home equity loan, you may be able to swap credit card debt at 15% or 18% interest for a 7% loan. Plus, home equity loan interest is tax deductible, effectively reducing the interest rate you’re paying on your debt.
6. Take a 401(k) loan
If you have exhausted nearly every other option, you may be able to tap into your 401(k) retirement savings to repay credit card debt without paying the early withdrawal penalty. How? With a 401(k) loan. (Note: This is different than cashing out your 401(k), which you shouldn’t do).
The benefit to repaying credit card debt with a 401(k) loan is that you repay interest to yourself, not a bank. The downfalls of 401(k) loans are that you loose out on any returns you would have earned and, if you leave your employer before your loan is paid off, the remaining balance is treated as a taxable dispersal that is subject to the 10% early withdrawal penalty. In general, I wouldn’t recommend a 401(k) loan, but it could be an option.
7. Negotiate with your creditors
If your savings are dried up, relatives can’t loan you money, and you don’t have a retirement fund or home to borrow against, it’s not time to file bankruptcy…yet. Before you even think of the “B” word, try calling your creditors and negotiating with them one on one. The trick? Threaten bankruptcy, even if you’re far away from considering it.
Nothing scares creditors more than a customer filing bankruptcy and many will do whatever it takes to help you avoid it—and help themselves to continue to collect money. They may offer to lower your payments, cut your interest rates, possibly even reduce the amount you owe. Everything is negotiable, but it will take time, and a lot of patience.
If you don’t feel like doing it yourself, you might consider enrolling the help of a debt management agency, but be forewarned, these agencies do charge a fee, and may not negotiate as good terms as you would be able to on your own.
8. When other options are gone, file bankruptcy
When we take on debt, we have a moral responsibility to repay it. Sometimes, however, repaying that debt (while still putting food on the table) simply isn’t possible. When you’ve reached that point, it may be time to declare bankruptcy.
But be prepared for bankruptcy’s nasty consequences. You’ll have a hard time getting new credit for up to 10 years, may be forced to surrender much of your personal property, and will have to pay filing and attorney’s fees in the hundreds or thousands of dollars.
Credit card debt is like financial cancer. Left untreated, it will grow and grow and choke your financial livelihood. With care and attention, even big debts are beatable, but it’s not easy. So suck it up, hunker down, and prepare for a long battle. Good luck!