ICFE eNEWS #14-03 - Jan 28th 2014
Getting Out Of Debt The Wrong Way
As a veteran financial counselor, I have seen numerous people who have
sincerely tried to pay off their debt but with little success. Their
desire was right but their method was wrong. Since experience is a good
teacher (especially the experience of others), we can learn from their
example and not follow them down the road to failure. That's what I call
"learning from the school of hard knocks without having to be enrolled."
There are indeed ways to pay off debt, and there are ways to avoid
because they simply do not work. That's the topic of our discussion
today - methods of paying off debt that do not work. Here are some of
the most popular.
- Paying down debt while continuing to use credit. Many couples make a
concerted effort to pay off their debts but they continue to create debt
while doing so. They pay on their credit cards each month, but continue
to use them. They soon notice that the more they pay off the credit card
debt, the more they have to use their cards. They are like a man trying
to fill up a bucket that has a big hole in the bottom; whatever goes in
at the top, comes out at the bottom!
After years of doing this, with little change in their debt balance,
they conclude in despair that they will never pay off their debt and
If we are to make any headway in paying off our debt, we have to "stop
the leak," that is, stop using credit and start living within our means.
We will discuss how to do this later.
- Paying down debt by only making minimum payments. Credit cards, for
example, require a very small % of the balance for the monthly payment -
normally around 1-2%. When credit cards were originally issued back in
the early 60's, the monthly minimum payment requirement was 5% of the
Consider the progress we would make if we paid off the average family's
credit card debt ($15,270) at the average rate of interest (15.06) with
a 2% minimum payment (Source: CreditCard.com, December 24, 2013). The
MSN.com credit card repayment calculator tabulates the results: With a
starting monthly payment of $305.40 (which becomes less each month as we
pay down the principle), it would take us 44.8 years to pay off the
debt. At the end of that time we would have paid $25,173 in interest
charges making our total debt payoff amount $40,443!
So, if we started our plan to pay off debt at age 30, we would reach our
goal just before celebrating our 75th birthday! Does that sound like a
good plan to anyone?
- Paying down debt with a second mortgage. This is one of the most
popular strategies, yet one of the most destructive. It not only does
not work, it makes things worse!
- It does not pay off debt - it only "moves" it to a new
location. To achieve less credit card debt by having more home mortgage
debt is not a good trade. Yes, I am aware that the interest is less on
a home mortgage loan and that that interest is tax deductible - but it
still is not a good trade! Our home is not an ATM machine to make
withdrawals to cover things we do have money for.
That means that when it comes time to move, we will have little
or no equity in our home, thus little down payment for our next home.
And when it comes time to retire, we are forced to make house payments
with our retirement income as we take on a part time job to make ends
meet. A 2010 survey by the Federal Reserve showed 41% of the people
surveyed ages 65-74 had mortgage debt. (Source: MarketWatch.com, June 5,
- It turns an unsecured debt into a secured debt. I know the
interest is less on a home mortgage, and is also tax deductible.
Nonetheless, it is rarely wise to exchange secured debt for unsecured,
especially when it puts our home at even greater risk for loss. You can
bankrupt unsecured debt, but if you bankrupt secured debt, you will lose
- It requires no change in our spending habits, and within
three years our credit card debt returns with an even higher balance.
- Paying Down Debt With Retirement Funds. Borrowing against our 401(k)
to pay down debt is also not a method to use. There often is a 10%
penalty to tap into our retirement funds early, plus the proceeds are
regarded as "income" and are susceptible to taxes. That means that if we
borrowed $20,000 from our 401 (K), we could forfeit $2000 up front,
plus potentially pay income tax on $18,000 of additional "income." The
cost of tapping our retirement funds under these restrictions is not
worth the cost.
Here are two lessons to learn by studying these four unsuccessful
- Any plan to pay off debt that continues to create the very problem
(debt) we are trying to solve will fail. In other words, borrowing to
pay off debt is like digging a hole in our front yard to fill in a hole
in our back yard.
- Any plan to pay off debt that does not require a change in our
spending habits will fail. If the process that created the problem
continues, we cannot expect the problem to vanish.
Our next discussion will talk about methods that do work.
© Jim Garnett, The Debt Doctor
AskMrG Consulting, LLC
2216 SW 35th Street
Ankeny, IA 50023
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