Debt is one of my biggest pet peeves. I HATE DEBT! Just to give you an idea of how much debt Americans are in here’s a few statistics from NerdWallet, $764 billion in credit card debt, $8.63 in mortgages, $1.17 trillion in auto loans, $1.34 trillion in student loans, and 12.73 trillion in other kinds of debt. The average credit card debt balance is $6,184.16. Households with new auto loans pay an average of $503 a month for 68 months. So you can see, we’re are a long way from debt-free living! I will say it again… I HATE DEBT! I mean I REALLY HATE DEBT! It’s a burden like no other, keeping you from living the financially simple life you desire and deserve. Most people have heard, “the borrower is a slave to the lender” from the book of Proverbs in the Bible. Not only have most heard it, but they are also clearly living it too according to those statistics. I’m not going to say all debt is bad, however, for the most part staying out of debt as much as possible is the only way to a financially secure future. There are plenty of get-out-of-debt strategies for you to employ if you’re serious about debt-free living. However, before you ramp it up and try one, know the pros and cons of first. Let’s look a few those tactics so it doesn’t cause more harm than good.
Cashing out a 401k might seem like a good idea when you’re in a pinch, but it’s the number one no-no! Seriously unless you are facing a financial hardship like no other… Don’t Touch It!!! The money you set back in your employer-sponsored retirement accounts should be off limits. You may be able to borrow from your balance, however, you’ll be paying it back plus interest. While contemplating this option is tempting, here’s the biggest caveat to it—if you lose your job (whether you’re fired or quit or whatever the circumstance), the loan must typically be paid back within 60 days. If you can’t get the money back into the account you’ll face a 10% early withdrawal penalty. That may not seem like a lot, but if you have $100k in the account and borrowed $25k, then you’ll be charged an extra $2500 in penalties. Also, you’ll also owe the IRS income tax for the $25k you borrowed. When you total all of the taxes and loans up, it’s often a lot more than the amount you initially borrowed. Look into other options, like a personal loan or perhaps tap your savings to pay down some debt (not your emergency fund, your regular savings). The truth is you likely don’t have enough saved for retirement anyway, and you just cost yourself compound interest.
Statistics from NerdWallet: $764 billion in credit card debt, $8.63 in mortgages, $1.17 trillion in auto loans, $1.34 trillion in student loans, and 12.73 trillion in other kinds of debt.Click to tweet
Just like your 401(k) is a bad idea, so is touching your IRA. Anytime you cash out a retirement account there are always implications you may not have thought through. Again unless it’s a life-altering circumstance, just don’t do it. You’ll pay the 10% penalty (there’s always a few exceptions to the rule, i.e. Roth IRAs) and be taxed like I mentioned earlier. Let’s say you have $10k in debt and $50k in the IRA. You decide to withdrawal 10k to get yourself out of debt. You’ll need to pull out at least $11k to cover the 10% penalty. Depending on your tax bracket, the total tax could be 30-40%. So the 10k withdrawal only netted you about $6-7k to pay off your debt. Not only did it cost you $4k to pull the money out ($3k in tax and a thousand dollars for the early withdrawal penalty), but had you kept that $10k invested in your IRA at an 8% interest rate over the next 20 years your IRA would’ve had about $50k more than it will if you cash it out. Anytime you’re considering touching a retirement account seek the advice of a financial professional so they can give you a clearer picture of what you’re about to do.
This is an especially popular option if you’ve amassed quite a bit of credit card debt. That 0% balance transfer offer probably look like a fantastic idea. They aren’t though and here’s why. The transfer will often cost you. Typically you pay around 3% in fees for moving the balance. While cutting your interest rate may be smart sometimes, keep in mind that interest rate isn’t forever. You’ll likely find yourself in the same situation again in six months to a year and if your post-transfer interest rate is higher than your current card, then you just cost yourself the fee plus more interest later.
Moral of the story, be careful about moving balances around. If you resort to a balance transfer to pay off debt, then you actually have a bigger issue. Opening new credit cards every few months is hurting your credit, not helping it. Learn to control your spending with a budget instead of a balance transfer. Manage your money don’t let it manage you.
Loans from a bank or credit union are fine. They can build credit. Loans from friends and family, not so much. Many relationships end up in ruins over money. Obviously, there are pros to borrowing from someone you know. You can get the money fast. There’s no credit check. They will probably offer a low-interest rate and possibly no interest rate. However, as I’ve said before, money is emotional and when you borrow from a loved one, things can get ugly really fast if you default on the loan. If this is your only option to clear up some debt, make sure you set clear terms and everyone is on the same page. That could save the relationship long-term.
Playing the lottery with high hopes of hitting it big occasionally or even joining in an office pool from time to time isn’t what I’m talking about here. Gambling will give you a high similar to drug addiction. Thinking you’re going to strike it big at some point to buy your way out of debt? DUMB, DUMB, DUMB! Playing online poker won’t put the odds in your favor. Big losses will land you in more debt as you keep trying to hit the jackpot. Rolling the dice with your finances just isn’t a good idea.
If you’re in serious debt, avoid these schemes. They’re not the way to go. Seek the advice of a good financial advisor. They can help you lay out a plan that will really lead to debt-free living.
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