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It’s never a bad thing to pay off debt, but there are right and wrong ways to go about it. To get out of debt efficiently, be sure to avoid these 9 mistakes you’re making paying off debt.
The Important Thing
We don’t want to wag our finger at anyone who is working to pay off their debt because the important thing, is that you’re paying your debt. We know it’s not easy. But we want you to pay off your debt as quickly and cheaply as possible. Because these 9 mistakes you’re making paying off debt can cost you.
1. It’s the Interest
If you’ve been paying off debt for what seems like forever, you know that the interest is the problem. Until your balance is ultimately paid off, the interest just keeps growing and growing. Since the interest is the problem, we want to see if we can lower the interest rate on our debts.
Credit card debt is probably the worst kind of debt to have because the interest rates are so high, on average, about 17% but some cards have rates well above 20%. Luckily, there are several things you can do to lower that rate.
Your best option is to get a balance transfer credit card. A balance transfer card is a credit card that has an introductory period ranging from six to 24 months that has a 0% APR. You transfer the balance from your current credit card to the new card. Usually, the new card will handle this for you. Just provide them with your account number and the amount you want to transfer (that will depend on the credit limit of the new card).
For the term of the 0% APR period, the balance you rolled over to the new card is not accruing interest. During this time, every penny you pay goes toward paying off the balance which means you can make progress more quickly. Any balance that remains after the introductory period will be subject to the card’s regular interest rate which might even be higher than the rate of your previous card, so it’s essential to get the card paid off before your time runs out.
Even if you can’t manage it, you’ll still have saved some money on interest. You do need relatively decent credit to be approved for a balance transfer card. You can go to Credit Sesame, get your credit score and a list of balance transfer cards that based on your score, you’re likely (but not guaranteed) to be approved for.
Make sure you do this, each time you apply for a credit card, your score falls a few points, so you don’t want to apply for a card that you’re almost certainly not going to get. Once you see which cards you might be approved for, choose the one with the longest 0% APR introductory period, so you have as much time as possible to pay off your balance.
If you have more credit card debt than can be transferred, a personal loan will be a better option. Again, you have to have decent credit to be approved for a loan.
You can take out a personal loan and use it to pay off your credit card debt. You’ll still have debt, the loan, but you will only have a single payment to make each month rather than a separate payment to each of your credit cards, and you will likely have a lower rate of interest. The rate you get depends on how good your credit score is.
You can apply for a loan from your bank or a credit union if you’re a member but it’s faster and easier to get a personal loan online from a peer-to-peer lender like Lending Club, Prosper, or Peerform. Most peer-to-peer lending sites let you browse your offers without impacting your credit score.
You can go to one of the sites, enter your details, and see the loan terms you’re eligible for. Once you apply, your credit score will fall a few points as it does when you apply for a credit card.
If your credit score isn’t good enough for either of the above options, your final option is to call up each credit card company and ask them to lower your interest rate. You don’t have a ton of leverage here. You can’t really use the old “I’ll close my account if you don’t play ball” move because even if you close the account, you’ll still have to pay the remaining balance.
And you can’t threaten to leave for another, better card because they can see your credit score and know you probably won’t be approved by another card. Your best hope is to be gentle and polite and appeal to the customer service rep’s humanity! And hope you get a sympathetic one.
Just explain that you’re really trying to get on top of your debt and you wonder if they might help you do so by lowering your interest rate. If the rep says no, call back until you get one who agrees to do it.
If you have student loan debt, the interest rates are likely lower than the rates on credit cards, but the balances can be five or even, gulp, six figures. But you may be able to refinance your student loans to a lower interest rate.
LendKey is a student loan refinancing company. You take out a new loan with a lower interest rate through LendKey which is used to pay off your current loans. You will then make a single monthly payment to LendKey. Because student loan balances can be so high, even reducing your interest rate by a solitary point can save borrowers thousands of dollars.
You can see your offers at LendKey in just a few minutes after answering some basic questions and doing so doesn’t impact your credit score.
Two caveats for those of you who have federal student loans. You may be eligible for a student loan forgiveness program. If you refinance, you will no longer be eligible. Find out if you’re eligible before you do anything because while refinancing for a lower interest rate will undoubtedly save you money, having your loans forgiven will save you even more!
Also be aware that if you refinance federal loans, you will no longer have access to student loan repayment programs like Pay As You Earn and Revised Pay As You Earn. These programs can help those struggling to make their monthly payments. Some student loan refinance companies have programs that can help if a borrower is having difficulty paying, but none of them are as comprehensive as the federal programs.
This is Number 1 on this list for a reason. Lowering your interest rates is the best way to pay off debt more quickly and cheaply.
2. You Don’t Have a Plan
You can’t successfully pay off your debt if you don’t have a plan in place. Just tossing money randomly at each debt means the cards will never be paid off. To pay off the debts faster and cheaper, you need to concentrate on one card at a time. There are two methods you can use.
Snowballing means you list all of your debts according to the dollar amount, lowest to highest. You pay as much money each month as you can on the first debt while paying just the minimum on the rest. After you pay off that first debt, you use the money you were paying on it to pay the next one on the list while continuing to pay just the minimums on the others. You continue this until all of the debts are paid.
Stacking works precisely the same way, but you list the debts by their interest rates, highest to lowest. You pay the first one off and move down the list.
Each method has its fans. Snowballing motivates because you can get some smaller debts paid off and it feels good. Stacking though is the method that will save you the most money. Since you’re paying off the high-interest debts first, you’ll pay less interest. The method that works for you is the best method.
3. You’re Only Paying the Minimums
While only paying the monthly minimums is recommended in both of the payment methods above, if you’re only paying the minimums on all of the debts, it’s going to take ages to pay them off. Sometimes the interest on a debt is so high that by paying only the minimums, all you’re doing is paying interest. None of the payment is going towards paying off the balance.
4. You Continue To Charge Things
Sometimes a person is really making progress on paying off their credit cards. Maybe they got a bonus or a big tax refund or even just started to drastically cut their spending and put all of that money towards their debt. They see all of that room on those paid down or paid off cards and promptly start charging stuff again.
Do not continue charging things on your credit cards while you’re trying to pay them off! I know this sounds like common sense, but a lot of people do it. It’s like pailing water out of a boat with a hole in it. As fast as you pail, it fills back up. You have to fix the hole.
Your “hole” might be that you live above your means, that you didn’t have an emergency fund and had to charge an unexpected expense, or that you really have a shopping addiction.
5. You’re Not Bringing in Extra Income
There are so many easy ways to make money online that there is no excuse not to be doing so. We all hate to cut back on our spending so often we don’t. For some of us, there is nothing left to cut. We’re living on a bare-bones budget already so we can put more money towards paying off debt.
6. You Don’t Appreciate the Seriousness
Your debt, especially high-interest debt like credit card debt, is an emergency. It really is. A fire is an emergency too, but you can’t ignore a fire the way you can ignore debt. When you ignore your debt, you are turning what is already an emergency into a potential disaster.
If you started a fire while using the stove, that’s an emergency. If you put it out, the emergency is over. If you ignore it, that small fire will burn down your house and everything in it. Ignoring emergencies results in a disaster.
You wouldn’t ignore a fire on your stove, and you can’t ignore your debt either.
7. Not Having an Emergency Fund
When we tell you to throw every dollar you can at your debt, we mean every dollar apart from the ones in your emergency fund. We know that being in debt feels scary and oppressive and that makes you want to get rid of it. Why would you let money just sit there in your checking or savings account when it could be going towards that debt?
Because life happens and you need some money to insulate you when it does. When you don’t have an emergency fund at all, you may have to use your credit cards or worse, a payday loan to cover it making an already bad debt situation worse.
Your long-term goal should be to have enough money in your emergency fund to cover six months of necessary expenses. That is a goal to shoot for once you’ve paid off your debt. In the meantime, your goal should be to save $1,000.
8. Not Working as a Team
If you and your spouse or partner have combined your finances, you both have to be 100% on board with whatever debt repayment methods and tactics you’re going to use. Money is one of the leading causes of fights, divorces, and breakups between a couple and it’s not hard to understand why.
Imagine if you were doing everything to pay off debt, working overtime, working a second job, bringing your lunch to work every day, while your partner was making no effort to help bring in extra money or to curtail their spending.
If your spouse or partner refuses to get on board, you’ll have to separate your finances as much as is possible. There are probably several other things you’re going to have to do to, but this is a personal finance article, not a personal relationships article!
9. Closing Accounts
What could be more satisfying than finally paying off a credit card and calling up the credit card company and telling them to cancel your card? That card got you into trouble, and you want to be rid of it forever.
Do not close credit card accounts once you’ve paid them off. We know it seems completely counterintuitive but doing so doesn’t improve your credit score, it decreases it.
The reason is that a few factors that make up your credit score are negatively impacted when you close a card. Length of accounts is one. The longer you have had credit in any form, the better your score. The calculation is an average of the age of all your accounts. When you close one, especially if it was one of your older ones, that average goes down.
Another factor is your total available credit. If you have two cards, each with a $5,000 limit, you have $10,000 in available credit. If you close one of those cards, the number drops to $5,000.
Utilization is another component of your credit score. Again, if you have a $10,000 total limit and have a balance of $3,000, your utilization is 30% (anything below 30% is considered “good.”). If you close a $5,000 limit card after paying it off, your usage is now 60%.
All of these things are going to lower your credit score. Don’t close accounts after paying off your credit cards. If you don’t trust yourself to use them responsibly, shred them and throw away the pieces (in different trash cans just to be safe). You can leave the accounts open without the physical card.
You do need to make sure the accounts stay active though if you’re not planning to use those credit cards anymore. If an account has no activity for a specific length of time, many issuers will cancel the accounts. What you can do is to put a small, recurring monthly payment on each card. Something like your Spotify account or your gym membership. Just a single monthly charge is enough to keep the accounts open and active.
No One is Perfect
Don’t feel bad if you’ve made some or even all of these mistakes while you’re paying off your debt. Many of us didn’t get much or any personal finance education. That’s part of the reason we get into debt in the first place, so it’s understandable we also wouldn’t know how to best go about paying off that debt.
But you’re here, educating yourself about how to get out of debt the right way. There’s nothing wrong with not knowing, only with not finding out.