Avoiding Debt Repayment Methods

Getting out of credit card debt is always worthwhile but it takes aggressive action and discipline to accomplish that goal. However, in desperation to get out of debt, many people turn to methods of paying down debt that can actually put them more at risk financially.

There are at least two methods of paying down debt that you should avoid.

Don't Use a Home Equity Loan or Line of Credit to Pay Off Your Credit Card Debt

If you surf online for advice about getting out of credit card debt, you'll come across a surprising number of recommendations from so-called "experts" recommending that you use a Home Equity Loan or Home Equity Line of Credit to pay off your credit card debt. Here's why that's bad advice.

Credit card debt is unsecured debt, meaning there are no assets backing it up that the lender can come after if you fail to pay what you owe.

A mortgage, Home Equity Loan, or Home Equity Line of Credit (HELOC) is secured debt. Your home is the collateral. If you don't pay according to the terms of the loan, the lender can seize your home as a way of obtaining payment.

You can get in trouble with Home Equity Loans and Home Equity Lines of Credit if a job loss, illness, divorce, death in the family, or other event makes it impossible for you to keep up with the loan payments. The lender can then force you to sell the home in order to repay the loan. When you do sell the home, you may not get what you owe on it, depending on market circumstances.

Don't Use a 401(k) Loan to Pay Off Your Credit Card Debt

Taking out a 401(k) loan is another bad way to pay off credit card debt because of the tax consequences.

Your contributions to your 401(k) are not taxed at the time you make them, but when you repay a 401(k) loan, you're making the payments with after-tax money. Later, when you withdraw the money for retirement, it will be taxed a second time. Being taxed once is bad enough. Being taxed twice is not a good financial move.

Bottom Line

It all boils down to this: don't use your home as a bank to fund your lifestyle or correct bad financial choices you may have made. When you use your home as collateral for a loan to pay off other debt, chances are high that you will get right back into debt with additional purchases, putting your home at risk.

Better Methods of Getting Out of Debt

Rather than put your home at risk, try these tried-and-true methods of getting out of debt:

• Realistic budgeting
  
  
• Live below your means
  
  
• Pay more than the minimum on credit cards
  
  
• Renegotiate terms with lenders
  
  
• Credit counseling from a reputable organization
  
  
• Debt consolidation
  
  
• Debt negotiation
  
  
• Bankruptcy, as a last resort
  
  

For other proven methods of paying off debt quickly see Managing Credit Card Debt where we talk about the Debt Snowball method.