4 Bad Ways to Pay Off Debt
- It's not good to pay debt with another loan unless it offers a lower interest rate, payment, or both.
- Withdrawing early from retirement accounts is a very expensive debt repayment scheme.
- Paying debts by NOT paying your taxes can get you into serious trouble with the IRS.
Paying off your debt is a great goal. Whether it’s student loans or credit cards, eliminating what you owe can help you feel free. And while any effort you make to reduce your debt is commendable, there are bad ways to pay off debt that could actually make your debt problem worse. As you take control of your finances, learn the repayment tactics to avoid and what to do instead.
1. Taking a payday loan
A payday loan sounds like a good way to tide you over until the next paycheck. However, most borrowers will not repay the loan in full when they do get paid, and might even make their debt worse by borrowing again. Payday loans can have an annual interest rate of up to 400%. To put this into financial perspective, this means that over 3 months, the interest on a $300 payday loan debt could grow to be as much as $270 compared to just $12 if it grew at 16% credit card interest.
What to do instead: Set aside part of your income—10% or more, if you can—into an emergency fund. Even $100, $500, or $1,000 can make a big difference in handling an unexpected medical bill or car repair.
2. Making an early withdrawal from retirement funds
Retirement savings, such as a 401(k) plan, can be crucial since Social Security is expected to cover only a portion of most people’s retirement expenses. In addition, if you pull out funds prior to the withdrawal age, you can incur hefty taxes and penalties, so you’d be forfeiting a large amount of your savings. That’s why early withdrawals from a retirement account are near the top of the list of bad ways to pay off debt.
What to do instead: If necessary, try other options for repaying debt—including debt negotiation, debt consolidation, or credit counseling.
3. Skipping tax payments
Choosing not to pay taxes so you can use the funds to repay debt is like jumping from the frying pan into the fire. You can face harsh federal or state consequences, such as interest and penalties on the debt, garnished wages, or possibly time in jail.
What to do instead: Talk to an accountant, tax attorney, or tax debt resolution firm as these professionals might be able to negotiate a lower payment for your taxes or your other debts.
4. Extending student loan timeframes
Stretching student loan repayment periods farther than you absolutely need to can mean you’ll be paying for college until you’re close to retirement! Extending your student loan can lower your monthly payment, but you’ll end up paying a lot more over the life of your loan.
What to do instead: If you cannot pay your student loan, contact the lender immediately to learn about possibilities, but be cautious of deferment programs that prolong the debt substantially.
Whatever type of debt you’re trying to pay off, think if there are alternative ways to find money for those payments: Can you take on an extra job? Get a roommate? Cut down on eating out of the house? Your future self will thank you for making sacrifices today, rather than choosing any number of bad ways to pay off debt which could hinder your future.
Consider alternative ways to attack your debt
Paying off debt the right way can help ensure you don’t make your financial situation worse. Getting out of debt is tough and you might still need help even though you have tried some of the above steps. If you’re struggling with debt or just worried about falling behind on payments, Freedom Debt Relief is here to help you understand your options, including our debt settlement program. Our Certified Debt Consultants can help you find a solution that will put you on the path to a better financial future. Find out if you qualify right now.
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