Paying off debt is a lot like going a diet. There are many ways to do it and some seem simple and easy like skipping meals; fad food diets; replacing meals with shakes or bars. The list could go on and on.
The best way to lose weight and keep it off permanently is to change your lifestyle by eating a balanced diet and exercising, but that takes discipline. Which is why so many people tend to ignore the hard stuff and look for the fast easy fix.
The same concept applies to paying off debt. There are many fast easy ways to get out of debt, but not all of them work and many of them are unhealthy for your financial future.
So with that said, let’s talk about some debt payoff strategies that sound like a quick fix, but they may not be in your best interest.
Debt Consolidation is a loan to pay off all your debts. Sounds good on the surface, but the only thing you are doing is trading one debt for another. If you are not disciplined and managing your money smartly, you’re simply moving debt from one place to another. The worst part is that you feel good because now instead of making eight payments to different credit card companies, you only make one payment which often leads to running up additional debt on the credit cards.
The other danger is that you have given a debt consolidator control over your debt payments and your financial future. If you ever use a debt consolidator, you need to retain the responsibility to monitor what they are doing by keeping up with the payments they’re making on your behalf.
Home Equity Loans are another option that seems like an easy fix. The equity in your home appears to be available money. If your house is worth $200,000 and you owe $150,000 on your mortgage, you may think you have $50,000 available for debt payoff. But if you run into financial trouble in the future and can’t make the equity loan payments, you may be at risk of losing your home.
Related to the home equity line of credit, selling your house may be a good idea. If you have too much house and the upkeep and maintenance are costing a bundle, you may be better off with a smaller home. Do the math. What is the cost of buying and selling? What percentage of your income is spent on your current house and what percentage do you estimate will be spent on the new house? Once you do the math, it may make more sense to stay put, buckle down and get serious about paying off the debt or selling and downsizing may be your best option.
Taking out a 401(k) loan is another perceived easy fix as it sounds like you are borrowing your own money. But look deeper. An early withdrawal from your retirement account (any withdrawal before age 59 ½ is considered early) means paying a 10% penalty plus income taxes on the withdrawal. If take a $30,000, the penalty will be $3,000. Taxes at your current income tax rate—say 28%—means the government will keep another $8,400.
This leaves you with just $18,600…. NOT $30,000 for debt payments. You actually wasted $11,400 in taxes and penalties. If you are 30 years away from retirement the future value of that $11,400 in your 401(k) at 7% is $86,799. Taking money out of your 401K is borrowing from your future and wasting money in penalties and taxes.
If you have a healthy emergency fund, it may be tempting to use that money to pay off debt. But don’t do it! As soon as that emergency fund is empty, emergencies pop up. The car needs a new transmission. There’s an insurance claim with a big deductible you have to pay. There’s a layoff at work. Avoid draining your emergency fund even if you’re doing something positive like paying off debt.
We all get frustrated with our jobs and you may decide to start your own business to control your own destiny. When that thought occurs, be careful. Typically, two-thirds of new businesses fail within 10 years. You may need a huge investment to get started. And where will the money come from to cover daily living expenses until your business becomes profitable? If you take out a loan to get started and do not make enough money to support yourself, you’ll be digging that debt hole deeper. (We’ve done this and it was a disaster!)
Scattering a little bit of extra money on all the loans may seem like you are making every effort to pay off debt, but it won’t get you very far very fast, and the lack of progress can be depressing. Instead of scattering a little bit of money in all directions, concentrate on paying off the smallest debt first.
Use any and all extra cash on the smallest debt and make the minimum payment on the others. As you knock out the smallest one, apply what you were paying on the smallest to the next smallest.
This method is known as the debt snowball, and according to the Harvard Business Review, it’s the most effective way to pay off debt. Their study found that people’s perception of debt pay off progress was not based on a dollar value, but rather on the portion of the balance they succeed in paying off. So paying off a $500 loan completely was more motivating that paying $750 on a variety of loans. This aligns with other research on the power of small wins to keep people motivated.
Playing the lottery in hopes of winning may be fun to think about, but it is never a viable solution. The odds of winning either the Powerball or Mega Millions are roughly the same: 175 million to one. Despite those odds, one-third of Americans believe that winning the lottery is the only way they will ever retire. Money you use to play to the lottery could just as easily be flushed down the drain to achieve the same results. Lotteries thrive by building a sense of false hope.
Instead of looking for the fast, easy fix, use a budget and work hard to pay off debt with a plan. It is the best way to succeed.
We have seen many people pay off enormous amounts of debt when they add prayer along with doing their part in making the necessary lifestyle changes. God hears our prayers, but we have free will to act or not.
If all you’re doing is praying and not taking responsibility in action, that debt is going to hang around forever! Instead of praying and then doing absolutely nothing to improve your financial situation, do both! It definitely works—we have lived it!
Tune into our podcast for more info about various plans to pay off debt.