7 Common Mistakes People Make When Paying Off Debt
Paying off your consumer debt can be one of the best ways you can improve your financial situation. Once you have paid off your debt, you also are finished paying interest to your creditors and have debt free living. The money that you were paying in interest can then be used for other items.
Paying off debt can help your credit score, which makes it easier to borrow in the future for purchases that can improve your net worth, such as buying a home. While paying off debt isn’t easy, it can be harder if you make some mistakes during the process.
1. Not Having a Plan
Knowing you want to pay off your debt is not enough to successfully work on paying off debt. Instead, you need to set clear goals and have a plan on how to tackle this task.
Decide which Debt You’ll Pay First
You need to decide which debt you want to pay off early. Some debt won’t make sense to pay off early, such as student loan debt or mortgages. These types of debts can come with tax breaks and may have lower interest rates so it doesn’t make sense to pay them off ahead of schedule.
In addition to figuring out which debts you want to pay off early in the process, determine which debts you want to pay off completely first. If you use the debt snowball method then you pay off the lowest balance first so you get momentum. If you use the debt avalanche method, you pay off the debt with the highest interest rate in order to save more money on interest costs.
Calculate How Much Money You Have Available
Figure out how much money you are able to devote to paying off debt. You need to pay off more than minimum payments if you want to make progress on your journey to becoming debt free. Set up a budget so you can see what you can actually afford each month.
You need to total up your debt. If you don’t have a clear understanding of how much you owe and whom you are paying it to then it’s much harder to create a plan to become debt free.
Part of your plan should not be making payments on a whim. If windfalls occur, such as tax refunds or work bonuses, then it’s a good idea to put that money toward paying of debt. However, if you just throw money at balances without looking at the overall picture, it can cause issues. This is why it’s important to have a plan and then stick to it.
2. Continuing to Spend and Creating More Debt
Figure What Got You into Debt
It’s important to change your spending habits and start to get to the root cause of the debt. Many credit card debts can start in a few ways. These include a job loss with no cuts in spending or a bunch of unexpected and random expenses that come in at once. Before you can get into a debt reduction plan, you need to address what got you into debt in the first place.
Change Spending Habits
Once you have figured out what got you into debt, you can’t continue to spend like you normally would. You can’t keep doing the same thing over and over again and then expect to get different results. In order to get out of debt, you need to know what is reasonable for you to spend every month and then change your spending habits to stay within your means.
Create a Budget
Creating a realistic budget can help you overcome unnecessary spending. Review your current expenses and then decide what is necessary and which ones are more than you can handle. Even making small cuts to just everyday spending can make a big difference. This could mean temporarily cutting services like cable or taking a break from dining out. It may require some serious lifestyle adjustments if you really want to tackle your debt.
When you continue to use your credit cards while paying them off, this doesn’t help either. Many people think they can get away with this by paying off the new charges each month plus the added amount toward the old balances. This is often driven by the desire to earn credit card rewards, such as cash back or airline miles. It doesn’t matter what kind of recordkeeping system you are using, this method hardly ever works. It usually results in extra interest being charged that exceeds any rewards you earn. You need to stop using your cards when you want to pay them off.
When you change your spending habits, you can also use this to your advantage when you are done paying off debt. When you are in the process of paying off debt, you may have to make some cuts that are uncomfortable, such as not eating out as much as you would like. When you get out of debt, you can resume some of your spendings but it’s best to stick to a budget so you don’t get yourself into debt again.
3. Not Saving for an Emergency Fund
Just because you are paying off debt, it doesn’t mean you can forget about your emergency fund. While it may seem counterintuitive to save money for emergencies when you want to devote every dollar you can to debt repayment, it’s necessary. If you don’t have money set aside when something unexpected happens then you will have to borrow money.
If you are making progress on paying off debt and then you have to put a large bill on your credit card due to an emergency, you will undo your efforts. You could get trapped in a never-ending cycle and then it’s easy to lose momentum. In order to make sure this doesn’t happen, you still need to have a small emergency fund so you can get started paying off debt. Start saving for emergencies with a savings account. Do your research and go with a reputable lender. Put in your information below for potential offers:
4. Not Focusing on the Right Debt
When it comes to paying off debt, not all debt is created equal. When you are way in over your head with debt, start to focus on any one that has a judgment against it or can put liens on you. Having your car repossessed or your wages garnished are not ideal situations and you want to avoid them at all costs. From there, focus on high interest balances since you are paying the most on these.
It may make sense to focus on debt consolidation for this to work. It’s important to find the right debt consolidation loan that makes sense for your situation. Some debt consolidation loans come with origination fees but you could make up for those with your savings if you spend some time researching.
Which debt you are focusing on should be part of your plan. If you have multiple sources of debt then it can be tempting to pay off a large portion of each one. Know which debts you are focusing on but don’t forget to make the minimum payments on each of your bills and loans.
Let’s Get Smart About Tackling Debt!
5. Using Debt Relief Programs Without Understanding
When you are overwhelmed with debt, it can be hard to find a solution. Credit counseling can be a legitimate option if you choose a reputable company that has your best interest at heart. There are different groups you can connect with to find professionals who review your financial situation, educate you on personal finance basics, and help you get back on the right track.
Customers need to be aware of shady debt relief organizations. Any for-profit credit counseling groups can be a red flag. You should also watch out for companies that make too good to be true promises or any guarantees about your debt relief. Initial counseling sessions should be free and not have strings attached.
Understand what you are signing up for before you start. Even programs that are there to help you with paying off debt will take time before you reach the results you want. Patience is key when working your way out of debt.
6. Messing with Your Retirement Savings
Just like not saving for an emergency fund is a mistake, so is not putting money in your retirement savings. Retirement savings help contribute to your financial stability after you stop working. The sooner you start planning, the better off you will be. Your current debt shouldn’t be swaying you from planning for you future and you should find other ways to cut your spending instead.
You also don’t want to tap into your 401k to pay down debt. While a 401k can let you borrow money and pay it back with interest, there can be significant tax implications. When you put money into your 401k, you are doing so with pretax dollars. When you pay back the loan, you are using after-tax dollars so you have to pay taxes again after you withdraw the money during retirement.
If you don’t make good on the loan terms then your loan is considered a distribution. If you are younger than the retirement age then that means you pay a penalty. If you leave the job for any reason then the balance will be due and you have to pay it back sooner than you originally planed. By taking your retirement money out of the market, you are robbing yourself of any future gains. When it comes to retirement savings, time is the most important factor. The longer you are invested then the more money you will have when it comes time to retirement.
7. Not Paying Attention to Your Credit Report
Are you taking the time to verify the information on your credit report? Many people don’t and this leaves them vulnerable to errors. Every year, you are able to receive one free copy of your credit report from the major bureaus. Take advantage of this and review the information. Look for any delinquencies or debt that isn’t yours.
Be sure to file a report if you are victim of fraud. Looking for errors on your credit report can help you keep your credit score high, which helps you get lower interest rates. Lower interest rates can mean you pay less on your debt and it can make it easier to pay down debt faster.
Also avoid any mistakes that can lower your credit score. For example, once you pay off your debt you may be tempted to close your credit cards. Part of your credit report is how much credit is available to you. If you close your accounts, you have less credit available to you and this has a negative impact on your score.
Additionally, it changes the average age of your accounts, which can also have an impact. Sometimes, it can make sense to close your card, especially if the card has a high annual fee. Keeping credit cards open and choosing to not use them is a better idea for your financial future. Another mistake that could be affecting your credit report is not paying your bills on time. Don’t get focused on one debt and then forget your other ones.
Ways to Get Out of Debt
Now that you know about some of the mistakes you can make when paying off debt, it helps to know how to get out of debt.
Share the Cost
Roommates can cut the cost of everything in half. You will spend less on rent, food, utilities, cable, and in some cases even transportation. The savings you can have can be enough to reduce some of your debt.
Take a Look around the House
Do you really need to be spending $100 a month on cable? Are you able to mow the yard and clean the house yourself? Can you exercise without a gym membership? Yes, these things are nice to have but not when you are in debt. Dump some of these items until you have paid off your debt.
Get Help
There is no need to go at this alone when there is help available. Non-profit credit counseling agencies can help you sort through the problem, set up a budget, and advise you on which debt relief solution suits you.
Check Your Budget
There can always be ways to shave some dollars and create extra cash to apply to your debt. One fewer night of eating out can give you $20 or more. Taking your lunch to work everyday can also save you money. If you watch a movie or sporting event at home instead of going out, you can save even more.
Forget about Your Credit Cards
Your credit cards likely got you into trouble in the first place. Keep one in your wallet for an emergency and then hide the rest away. Pay for everything else in cash. It’s much harder to hand over cash for purchases than it is a credit card. This can eliminate any impulse buying.
Go Shopping with a List
The grocery store or the mall can be a dangerous place if you take a credit card. Make a list of what you need and then only buy what is on the list. Get in and get out.
Tools to Help You Get Out of Debt
Motivation, having a budget, and changing your spending habits are all useful when it comes to paying off debt. However, there are also debt financing tools to help you with the process.
In certain cases, a 0% balance transfer credit card can give you immediate relief from a credit card with a high APR. However, balance transfers are not a cure-all solution. A balance transfer works as a way of attracting new customers. A credit card company will let you transfer a balance from one credit card to a new one and offer 0% interest for a certain number of months.
This helps save a lot on interest if you are careful. For example, if you transfer a $2,000 balance from one card with a 15% APR to a new card with 0% APR then you can save up to $300 in interest.
You do need to be aware of different things. There can be a fee to transfer a balance and this can eat into what you are saving. It won’t fix your debt problem if you aren’t able to make payments big enough to chip away at the debt. However, it does buy you some time. You need good credit to get approved for a credit card. If balances on your current credit cards are too high then you could be denied for this. A balance transfer gives you more credit and with more credit, you can have more temptation to spend. Try using a balance transfer calculator in order to see if a balance transfer could work for your situation.
It is much easier to find unsecured personal loans that you can use to consolidate your multiple debts into an affordable payment. You do still need to have decent credit to get a personal loan. However, you may be able to qualify for a loan when you don’t qualify for a new credit card. If you have excellent credit then it’s possible to get a lower interest rate with a personal loan.
Your interest rate could be significantly lower than what you are currently paying on your credit cards. Personal loans also have fixed terms, usually three to five years, and one monthly payment.
This makes it easier to pay off all your debt at once. You also aren’t tempted to just make the minimum payments. You know your debt will be paid off at the end of the term. If you are serious about this route then you need to do research to find the best personal loans.
When searching for personal loans, be sure to check the interest rate and the terms of the loans. Some loans will have extra fees tacked on that could eat into savings. When comparing loans, compare apples to apples and know what you are getting.
You can save some money by working on getting out of debt on your own but sometimes you may need some extra help. Working with credit counseling and debt management companies can be great, as long as you are making a mistake. Avoid any debt settlement scams that promise to reduce the total amount you owe and avoid any ones that charge big fees upfront. With a debt management plan, a third-party company helps negotiate interest rates, payment amounts, and fees with your creditors. You then make one monthly payment to the third-party company and the company then pays your creditors.
Homeowners can take out home equity loans to pay off different debts. This can be effective if the loan features a lower interest rate. Many people like this strategy since these loans usually do tend to feature lower interest rates with sometimes deductible interest. However, it does reduce your home equity and puts the home at risk. If you don’t pay back the loan, it’s your home that is up for collateral and you could lose it. Again, you need to have the discipline to pay off the loan. If you use the money to pay off your debt and then rack up more debt, going through the process may not be worth it.
Ways to Pay off Debt Faster
If you are working toward paying off debt, there are some things you can do to make the process faster.
Use Unbudgeted Income
Every time you get a tax refund or some unexpected money, spend the money toward your debt.
Ask for a Rate Reduction
If you haven’t already looked to see if you are locked into the interest rate you are paying, now is the time to do so. If you have been a consistent payer then the credit card company does want to retain your business. See if you can get your interest rate lowered. You will never know until you ask.
Ask for a Raise
If you need to be making more money, it may not be a bad time to ask for a raise at work. The worst that can happen is you get a no.
Generate More Income
This is taking on a second job. Many people say they don’t have time for a second job but if you have time to visit restaurants, shopping malls, and gyms, consider that those things cost time and money. Use any available time you have to make money and then put the money toward you debt.
Pay Bills on Time
You are giving away money when you pay your bills late and have to pay late fees. Landlords, credit card companies, and banks love late fees since they don’t have to do any extra work to get money. Be sure you aren’t giving away your money by keeping track of due dates.
Have a Garage Sale
Nearly everyone has stuff they don’t use anymore. Let someone else take away your junk while you make some money.
Debt Consolidation Only Works if You Have a Plan for Paying Off Debt
Debt consolidation only works if you aren’t making the mistakes listed above. Debt consolidation can work if you have a plan to pay off your debt. This is another reason why it’s so important to not make this mistake in the beginning and really spend the time coming up with a plan.
Debt consolidation may work if your debt is significant but it’s not quite out of control. If you are able to pay off the debt in the next five years then consolidation may work. However, if it’s possible for you to pay off your debt within six months to a year then the cost of a personal loan and the amount you would save isn’t worth the hassle.
If it is going to take you more than five years to pay off your debt then a personal loan may not be enough for you. Your credit score can be a huge factor in whether or not debt consolidation will work for you. You need a high score in order to get the best rates and really utilize the benefits of getting a personal loan for debt consolidation. If you aren’t able to beat your current rate with a personal loan, there may still be an advantage for your situation.
You do get a fixed monthly payment where you know your debt will be paid off at the end of your term. This makes it harder for you to just get stuck in a trap of just only making minimum payments all the time.
Conclusion
Paying off debt may not be an easy task but you can feel so accomplished once it is done. In order to successfully pay off your debt, you need to make sure you aren’t making some of the top mistakes that others have made. There are different ways to get out of debt and ways to pay off your debt faster if you want to. There are also tools that you can use to help make paying off debt easier. Carefully look at your situation before you decide to move forward with any plan to make sure it makes the most sense for you.