There are many responsible strategies for paying off credit card debt. You could trim your spending and direct the extra cash to cut the debt. Or, you could open a balance transfer card and consolidate all of your credit debt onto one low-rate card.
But there are shortcuts you don’t want to take to pay off credit card debt. Read on for details on six of them.
Paying just the minimum.
Taking money from retirement accounts.
Robbing emergency savings.
Tapping home equity.
Skipping the mortgage payment.
Taking out another loan.
The Bankrate Daily
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No. 1: Paying just the minimum
If you want to get out of credit card debt, paying the minimum each month is the slowest way to get there. It’s also incredibly expensive.
For example, say you have $5,000 in debt on one credit card. Your interest rate is 15 percent, and your minimum payment is calculated by adding interest to 1 percent of the balance. If you pay the $112.50 minimum required each month, it will take 266 months, more than 22 years, to pay it off. And you’ll end up paying $5,729.21 in interest on top of the original balance.
You could get a personal loan to consolidate all the debt into a fixed monthly payment at rates that are usually lower than average credit card rates.
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No. 2: Taking money from retirement accounts
Using retirement savings to pay off credit card debt is expensive.
Besides raiding your future financial security, you could owe taxes to the IRS if you withdraw tax-deferred money from certain retirement accounts. Additionally, you may incur a 10 percent penalty if you withdraw funds too early.
Instead, consider temporarily stopping contributions to your retirement account and use that additional money to pay off your credit card, says John Ulzheimer, a nationally recognized credit expert formerly of FICO and Equifax.
The interest you’re paying each month as balances roll from one month to the next is outpacing the returns you’re earning from your monthly contributions, he explains. Just remember to restart your contributions as soon as you clear your credit card debt.
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No. 3: Robbing emergency savings
Fight the temptation to use the cash in your emergency fund to pay off credit card debt.
“Losing your job is an emergency. Paying off your credit card is not,” Ulzheimer says.
Draining your emergency fund to pay off credit card debt exposes you if a real emergency strikes. You could be vulnerable for a year or longer as you replenish the savings. What constitutes a real emergency? Things such as a medical issue, natural disaster or job loss.
Ulzheimer says if you feel compelled to use those funds, don’t wipe them out. Use a small portion along with other available cash as a stopgap for your credit card debt.
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No. 4: Tapping home equity
There’s some debate as to whether pulling equity out of your house to pay off credit card debt is a good idea. Ulzheimer points out that many homeowners have traditionally tapped home equity to help pay for other debt such as credit cards. However, some homeowners may not even have that option because home prices have yet to rebound in their area.
“Put a check in the ‘careful’ column,” says Ulzheimer. “If you have equity, you don’t want to push yourself too close to 100 percent loan-to-value. You’re endangering your home.”
A personal loan can be a viable alternative to tapping home equity to pay off debt. Check loan rates and estimate your monthly payments.
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No. 5: Skipping the mortgage payment
Paying the credit card bill instead of the mortgage payment is also a huge risk and leaves you vulnerable to foreclosure.
Sadly, this strategy became more common after an unprecedented drop in home prices put more homeowners on the brink of losing their homes, says Barrett Burns, president and CEO of VantageScore Solutions, the company behind the credit-scoring model VantageScore.
It is all too common for families to depend on credit cards as lifelines to pay for the basics and get overextended. It’s OK to use credit cards in this way, as long as you can make the payments and keep those credit lines open, Burns says. It becomes a problem when keeping the lines open means missing a mortgage payment.
Credit card issuers are quick to shut down delinquent credit lines because they are unsecured debt. The road to foreclosure, by contrast, is much longer, and many homeowners recognize they could have as long as a year before they are evicted. Still, a house is most Americans’ largest asset, and jeopardizing it to save a credit card could come back to haunt you.
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No. 6: Taking out another loan
Avoid payday loans at all costs, Ulzheimer says. Title loans, or loans against a car, are usually too costly to pay for overspending.
However, Ulzheimer recommends considering a signature loan, or unsecured personal loan, from a bank or credit union.
You’ll want to make sure you can qualify for this type of loan at a reasonable rate and an affordable minimum payment. Sometimes the rate is better than a credit card. And be ready to give proof that you have the income to pay back the loan.
The drawback? These loans typically come in small amounts, from $1,000 to $35,000. So, if your credit card debt is huge, a signature loan may not cover it all.