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Worst Ways to Pay Off Debt
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In today’s society, debt is more than common — it’s expected. Now, while some debt can be healthy, like routinely paid student loans, a mortgage, or sometimes a car loan, debt is notorious for snowballing. Ultimately, all debt needs to be paid off. Everyone takes a different approach to debt management, and some are more responsible than others.
If you don’t have a plan, it can take years and be extremely expensive to pay off your debt. Even seemingly small financial errors can result in damage to your credit score, not to mention worse risks like bankruptcy. To avoid this, it’s important to handle your finances prudently and to avoid common pitfalls associated with debt management and repayment.
The Worst Ways to Pay Down Debt
Managing your money properly means knowing what to avoid, and this is even more important when it comes to debt. Even one misstep can result in costly consequences, so familiarize yourself with common pitfalls so you can sidestep gracefully.
Problem: Using High-Interest Loans
Though cash flow issues cause a lot of stress, turning to these quick fixes sets you on a risky path. These loans are well-advertised, with flashy signs for payday loans on every corner. From credit card cash advances to car title loans, getting cash quick isn’t the problem — it’s what comes after. The loans are easy to get but they also come with exorbitant interest rates, not to mention the high fees and penalties written into the agreements.
- Financial Risks: The risks of high-interest loans are extreme. You can lose your vehicle for defaulting on a title loan; and, since these loans are often structured to force you into a vicious cycle of debt, it’s a problem countless consumers have encountered.
Problem: Minimum Payments
Most Canadian consumers have credit cards, a form of revolving debt that can snowball (quickly). While it can sound enticing to pay only the minimum amount every month, it is a slippery slope that’s hard to navigate. Sure, paying the minimum on-time prevents default fees and your credit file from showing delinquent behaviour, but this habit has a dark underbelly that can lead to long-term financial issues.
- Financial Risks: Though you’re avoiding some issues, minimum payments means you aren’t paying off the bulk of your balance. It results in your account incurring more interest and ultimately increases the amount of debt in your name (something that also impacts your credit score).
- Potential Solution: The alternative is paying a fixed amount each month. For instance, consider a situation where you owe $5,000 on a credit card with 15% interest. If your minimum payment is 5% (roughly $250 per month), it would take nine years to pay off the debt. During that time, you would pay $1,631.59 in interest. Conversely, you could pay a fixed amount of $350 per month and it would take just 16 months to repay. Plus, you would only pay $542.54 in interest (less than half the amount you’d pay with minimum payments).
Learn more about the consequences of making partial payments.
Problem: Debt Settlement
Though it can sound appealing (and for many, it is a suitable option), debt settlement comes with its own set of risks. On the plus side, it can eliminate issues with late fees and non-stop calls from creditors. It is also a way to halt any negative impact on your credit score.
- Financial Risks: The most important thing to understand is that debt settlements aren’t always successful. Yes, it works out for many. However, chances are it took an unexpected situation to cause the debt in the first place. If that happens again, you will still owe money, plus hefty late fees, and a dangerous interest rate.
Consider a debt consolidation loan or a debt management program instead.
Problem: Using Your Home’s Equity
It might sound straightforward: your home is an asset, so why not use the equity? But choosing to liquidate your equity has some serious downsides, especially over the long term.
- Financial Risks: Tying bad debt to your home equity increases the risk of losing your home substantially. While there are risks associated with defaulting on your payments, few things are as risky as gambling your home equity. Unless you know that you absolutely can pay off the amount in a timely manner, this is something to avoid.
Problem: Credit Card Balance Transfers
Like most financial maneuvers, this approach isn’t suitable for every situation. This is when you transfer the balance of your existing card to a new card with an interest rate promotion. It can be a suitable approach if you are certain that you can pay off the debt before the promotion ends. It also can work if the interest rate after the introductory offer is lower or equal to your existing rate of interest.
- Financial Risks: If you aren’t able to pay off your principal balance before the end of the trial period, you can be left with a rate higher than you would pay otherwise. Also, if you spend money on the new card, you can lose the upper hand quickly. Many cards come with balance transfer fees, so be sure to calculate what you will pay in fees versus what you stand to save. Ensure that it is worth the effort and that you can actually save before you make your decision.
Are Your Having Trouble Managing Your Debt?
Though there are some risky ways to pay off your debt, it is possible to generate a good plan, whatever your circumstances may be. The key is to plan ahead. Even if it’s tentative, sketch out a budget and update it regularly. As the adage goes, slow and steady wins the race, though there are some things you can do to accelerate the race against debt:
- Pay your most expensive debt first. Identify the loans with the highest interest rates and prioritize those payments whenever you have extra money to put toward debt repayment. This lets you keep up with minimum payments on other cards while reducing your overall debt load faster.
- Aim to pay more than the minimum amount. Issuing a payment over the minimum requirement means that you pay less interest. This reduces the time it will take you to pay off your debt and the amount you pay overall.
- Make a budget and stick to it. Gain a full understanding of your income and your spending. By knowing how much you have available to spend, you can avoid adding to your credit card balances. It also tells you how much extra you have to apply to your existing debt.
- Consult a professional debt specialist. If you are still struggling with your finances despite your best efforts, reach out for help. Debt specialists are trained to evaluate finances and curate a personal debt-management solution to your needs.
Instead of letting debt snowball through inaction, there is always something you can do. By avoiding the worst approaches to debt repayment, you can focus on financially healthy decisions. Take an honest look at your debt and income and make a plan to tackle it so you can shore up a better financial landscape in the future.
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