Here are 3 things you should NEVER do to pay off your credit cards
If you have credit card debt, getting it paid off should always be your first financial priority (besides paying for basic living expenses for you and your family). In fact, getting my credit cards paid off once and for all is my biggest goal for 2016.
But as much as I want to get my credit cards paid off ASAP, there are some things I will never do to pay them off, and you shouldn’t either.
1. Don’t Take Money From Your 401(k)
I personally don’t think it’s a bad idea to take money from a regular savings account that is earning almost 0% interest and put it toward credit card debt.
Most personal finance experts agree that if you have more than $1,000 or $2,000 in savings, you should put the rest toward your credit card debt. This is because it doesn’t make sense to be paying 10%, 15%,or more interest on credit card debt while you have money sitting in a savings account earning almost no interest.
However, one thing you should not do is take money out of your 401(k) to pay off your credit card debt. The problem with taking a 401(k) loan to put toward credit card debt is that the money you invested in there is pretax. But when you repay the loan you will do so with after-tax money. Then when you withdraw money from your 401(k) during retirement your money will be taxed again. This essentially means that you will be paying tax twice on the same money.
The other issue with taking a 401(k) loan to pay off credit card debt is that if you change jobs or get laid off before you’ve repaid your 401(k) loan, you will be required to pay it back very quickly in a matter of a few weeks. If you don’t have the funds to do this, you will then be taxed as if you took an early withdrawal from your retirement account. You will pay the ordinary income tax on those dollars, plus a 10% penalty.
2. Don’t Use a Home Equity Line of Credit
One difference between credit card debt and a mortgage is that a mortgage is secured debt and credit card debt is unsecured. This means that if you don’t pay your mortgage, you home could be repossessed by your lender and sold in a foreclosure so they can recoup the money left on your loan. But if you don’t pay your credit card debt, the credit card company cannot force you to sell your home to pay the bill.
When you take out a Home Equity Line of Credit (HELOC) you are taking out more debt against the value of your home. This might sound like a good way to pay off your credit card debt as a HELOC usually has a lower interest rate than a credit card. Plus interest paid on a HELOC is tax-deductible.
These two “benefits” often make a HELOC seem like a good way to pay off credit card debt. The reason you should never use a HELOC to pay off credit card debt is because you are transferring unsecured debt into secured debt. If you miss payments on your secured HELOC you could lose your home.
Additionally, many people who use a HELOC to pay off their credit cards will end up charging more on to their credit cards again. Then they will have to deal with having credit card debt and a HELOC to pay off.
3. Don’t File Bankruptcy
Filing a personal bankruptcy seems like an easy way to get your debts forgiven so you don’t have to pay them off, but in reality filing a personal bankruptcy can actually be a bigger financial mistake than getting into debt in the first place.
It’s true that filing a personal bankruptcy will discharge you of the responsibility of having to pay off your debt (except student loans which are rarely forgiven during a bankruptcy), but the effect of filing a bankruptcy will stay with you for many years to come.
A bankruptcy filing will damage your credit score and will remain on your credit report for seven to 10 years. If you plan to move and purchase a new home or buy a new car during that time period, it will be difficult. If you are approved for a loan for those purchases at all, the interest rate will be substantially higher for you than for someone who doesn’t have a bankruptcy filing on their credit report. The cost of extra interest can end up being more than you would have spent to pay off your debt yourself instead of filing a bankruptcy.
If at all possible, you should try to pay off your debts yourself instead of filing a bankruptcy or using these other methods of paying off your credit card debt. This includes exploring all methods of paying off your debt, including working with debt counselors and consolidation agencies. You can find legitimate debt counselors recommended by the National Foundation for Credit Counseling. These companies will help you dig out of debt by negotiating with credit card companies on your behalf.