Some things you can
easily neglect or forget without causing any harm, such as what the last two
answers are in the crossword puzzle today; but you cannot do that to a debt.
Debt stays like a recurring nightmare in the night, haunting us and chasing us
like Mr. Anderson in a Matrix world, charging compounded annual rates of 20% or
more of monthly interests. We are stuck in that world’s system – with no escape
in sight. But there is a way out of debt, using our free debt-crushing
strategies -- and with the help of some of your rich friends and wealthy
relatives (see tip No. 5). The nine ways to escape this enslaving system
follow:
1. Exceed your monthly dues
The first step toward
freedom from debt is to pay above the demanded minimum monthly payment. Do not extend
your burden of paying the usual 2% to 3% of the outstanding balance for the
required payment term. Moreover, banks would enjoy such subservience, even
wishing you would pay for longer terms to increase their profits. Tell yourself
now that it is time your own happiness is your priority, not the banks.
The strategy is to pay
as much as you can afford regularly for every month. For instance, if your
minimum amortization is $200, make it $150 or 200 even more. Try to look into
your daily or monthly expenses to see where you can get the extra money. (To
find some tips on how to do this, read our Living Below Your Means discussion
forum.) For example, minimize or eliminate dining out and cook at home.
Desserts are things we can do without, if you think about it. Happy hours would
not be so happy if you think you have a debt to pay off. "Luxuries",
in short, are things you can do without and are rich sources of hard cash.
The operative word (as
in, you need to get it out of your system through some form of mental surgery)
is “sacrifice”. Then, you will find a way to drastically up your debt
amortizations. It is the best way to save valuable money that would go into
paying interests. Moreover, you will have a faster way of escaping your
“debtly” situation. There is no joy in that kind financial crisis, having to
live in constant penury and fear.
2. Snowball your debt payments
If you have credit
cards, think seriously of how you can win some more points. Which one gives the
lowest rate of interest? If you have not gone beyond the highest amount allowed
on that card, try moving your higher-interest bill to it. This is allowable in
most cases. Why pay 18% if you can pay only 12%?
In case your total
credit balance does not fit on your low-interest card, pay at least the minimum
amounts required for all cards except for one. You can then transfer most of
your debt repayments into that one credit card, and do it as fast as you can.
Once the balance on that card is zero, transfer the next by applying the same
rapid repayment scheme.
This is what
“snowballing” means – one small step at a time until you accomplish more. While
the debt is decreasing, the money you will need to undo your debt will
increase. The money you use to pay off “snowballs” until your debt disappears.
You see how easy it is?
One alternative means
of moving higher-interest debt to a lower-interest card involves the use of
promotional offers from banks which provide credit card facilities. Note such
ads offering to "Transfer all your credit card balances” to them at only
“5.9%" for a period of a year. Why not? 5.9% is far beneficial to you than
18% interest. It would be unwise not save all that money in interest which
could be funneled to reduce the principal every month, effectively decreasing the
outstanding debt balance even more.
But think before you
bite into any offer. Check properly the details for any possible catches. For
instance, find out whether the interest rate will remain at the offered rate
after the introductory period expires or revert to what you pay now. This would
mean changing again and other possible surprises along the way. Banks have
become wary of credit card holders who jump from one card to another to avail
of the low introductory interest rates. Many such offers now stipulate that
once you move outstanding debts from the new card within a year, the regular
interest rate will revert retroactively to all outstanding balances. That
stipulation might come as a big burden to bear for cash-strapped individuals,
giving no relief whatsoever. The fine print tells it all – if you can read
patiently.
3. Withdraw your savings account
You can decide to
withdraw your savings and
investments and slowly pay off your debt using the proceeds. It might
appear unwise; yet, sometimes one has to play the fool to survive. Even at 12%
rate, your investments would need to bring in above 18% before paying all taxes
to match the dollars flowing out. Besides, the money in your savings account
will not earn you close to that rate of interest. Terminating the debt this
way, amounts to achieving that 18% gain, minus any risks involved otherwise.
The greater the interest rate you pay, the more desirable repayment becomes
against any existing investment.
4. Take out a loan using your life insurance policy
Does your life
insurance policy provide a cash value? Then, make us of it by borrowing your
own money. The interest rate is usually way below commercial rates; and you can
have longer terms to repay the loan. Be sure you pay it faithfully. In case you
die prior to repaying the debt, the remaining loan balance and interest will be
taken from policy’s face value due to the beneficiary. Indeed it is a small
burden to carry now to try to remove a debt than allowing your loved ones to
carry the burden, if you leave them permanently before paying it back.
5. Persuade family and friends for help
There must be a
relative or friend who trusts you and cares enough to reach out to you with a
helping hand. If so, you stand to get a loan at a bargain rate with less
pressure on the payment schedule. In order to keep your relationship intact,
frame up a formal agreement on paper to clarify expectations on either side as
to interest and repayment scheme. This will do away with any hurt feelings or
doubts in the future. And try to stick to the agreement if you want to remain
welcome at family, office or school events.
6. Acquire a home equity loan
If you have a home
whose equity has piled up over the years of paying the mortgage, why not get a
home equity loan (HEL) credit facility at the highest allowable amount?
There are two ways
that a HEL can help you save: first, applying the loan amount to your debt
repayment, which allows you to exchange an 18% loan, for example, for a 6%-7%
loan; second, itemizing deductions when you file your income tax credits HEL
interest as a deductible item in most instances. A 25% marginal tax bracket
will provide the 6% loan an effective rate of 4.5%, which is probably the best
deal you can get on a personal debt.
Avoid, however, the
common pitfall of getting an HEL, paying out your current debt and then ringing
up credit card charges once again. That will give you two birds to shoot at
with a single bullet, since you cannot afford another bullet to solve both
challenges. Avail of HEL to erase your credit card debts, and then pay off HEL
as well. Makes you appreciate your dire situation and the meaning of the
saying, “There’s HEL to pay!”
7. Avail of a loan through your 401(k)
If you have a 401(k)
retirement plan, yours may have a facility for loans up to 50% of your
account's value, or $50,000, whichever is smaller. Usually, the rates are one
or two points above prime, making them lower what credit cards charge. This
makes 401(k) plan loans a way to pay off your debts. The best thing about this
scheme is not just the lower interest but that you pay it back to your account
as each dime paid on interest goes straight to the borrower's 401(k) account
and not the lender's.
The downside on this
plan includes the following: first, you repay the loan and interest with
after-tax dollars, and the interest will be subject to tax again when you
finally withdraw money from the 401(k) in the future. Moreover, the loan
repayment period is five years. Leaving your work before repaying the whole
loan will, therefore, require you to immediately pay off the loan. If not, that
amount will be considered as a distribution to you and subject to tax at
regular rates. And in case if you are below 59 and one-half years old, an
additional 10% excise tax will be charged as penalty for cashing out your
retirement funds early. Hence, make certain your 401(k) loan can be fully paid
prior to leaving your job.
8. Restructure your loans
Are you at your rope’s
end? No savings left. Friends and relatives cannot be of help. You do not own a
home or a 401(k) account to loan against. In short, you are wiped out and you
consider filing for bankruptcy. Wait! Hope always shines in the darkest places.
Ironically, the prospects of bankruptcy can be of use to you.
If your creditors
become aware of your situation and that you cannot renegotiate, your only
recourse is to declare bankruptcy. You may seek a lower repayment term; ask for
a lower interest rate; and satisfy their demand for payment. Creditors, more
often than not, will choose to receive any deal where they get to recover some
of their investment rather than nothing at all.
The transaction table
is always open to a reasonable compromise where everyone wins and no one loses
anything. It is worth a try and in time you will realize such recourses do work
for the best. There are even organizations which will do it for you, in case
you are not sure what you need to do.
9. Final option: Declare bankruptcy
If it comes down to
the last option you have left, file for bankruptcy. As much as we all want to
pay our debts, sometimes repaying is not at all possible. But be aware of the
consequences.
For ten years, you
will have a credit record with this bankruptcy information, making it hard for
you to acquire a loan for that long. Furthermore, it is ironic that filing for
bankruptcy requires a lot of money. Hundreds of dollars of lawyer fees and
court filing expenses have to be met to get the relief you seek. With tougher
bankruptcy laws in the offing as well, you might end up not obtaining any
relief at all.
Two kinds of personal
bankruptcy relief are available: Chapter 7 and Chapter 13. Chapter 7, called
straight bankruptcy, provides almost total relief from debts, not including such
items as alimony, taxes, child support, loans acquired through filing false
financial records, loans not included in the bankruptcy petition, student loans
and legal decisions against the petitioner.
Although Chapter 7
frees you of the duty of paying back most creditors, you may need to give up a
big part of your property to partially pay off the debt. Nevertheless, some
states have different laws providing exemptions on particular types of
property, for instance, a specific amount of home equity, an old or low-value
vehicle, minimal worth of jewelry and other personal belongings, and tools used
in the pursuit of one’s business or occupation. Although such exemptions are
quite small, no one will need to start over from zero.
Chapter 13, also
referred to as the "wage-earner plan," is quite different. You can
hold on to your property but give up all financial control to the bankruptcy
court. The court recommends a repayment scheme based on your financial capability for
paying off all or part of your debt for period of 3 to 5 years, during which
creditors cannot harass you for any payment. You are also free of any interest
charges on your debts during that period. Once the requirements of the
court-approved scheme have been satisfied, you come out debt-free from the
bankruptcy.
This article is based
on a David Braze article with a few revisions.
