Chapter 4: Delete Your Debt

If you owe money on your consumer credit or charge cards now, it is a good idea to develop a plan to repay it as quickly as possible. Finance charges make holding onto balances extremely expensive. There are several methods you may be able to use to delete your debt efficiently.

Develop a Repayment Strategy
With commitment, a positive attitude, and a few key tools, you can delete your debt efficiently:

• Pay more than the minimum. A $2,000 debt at 18 percent interest will take about 30 years to delete if you just paid the typical minimum payment of two percent.
• Determine a realistic and fixed amount you can pay each month.
• If you do use credit, only charge what you can repay when the bill comes in. It doesn’t make sense to add to the balance when your goal is to pay off your debt.
• Contact your credit issuers to request a rate reduction – if you have had a long and consistent payment history they may offer you a better deal.
• Consider transferring your balances to lower rate cards.
• Examine your statements to see which accounts you are paying the most in finance charges – then pay as much as you can to that debt while paying the minimum to the others. Once that account is paid off, concentrate on the next most expensive.
• After you have built up emergency savings, use extra cash to pay off debt. It doesn’t make sense to pay 18 percent interest on a debt while your savings is only earning two percent interest.
• If you get a raise or a bonus, apply at least some of it to your debt.
• Revisit your budget and make choices about where you really want your money to go. You may decide to spend less on some items, at least temporarily, so you can speed up debt repayment.
• Close open lines of credit if they are too tempting.
  

Home Equity
If you are a homeowner, using the equity in your home to pay off unsecured debt can be a wise decision. Low annual percentage rates, tax-deductible interest, and a single monthly payment can make second mortgages extremely attractive. These second mortgages come in two basic forms

• Home Equity Loans – With a home equity loan, you will receive the cash in a lump sum when you close the loan. The repayment term is usually a fixed period, typically from five to 20 years. Most lenders allow you to borrow up to the amount of equity you have in your home.
  
  
• Home Equity Lines of Credit – A home equity line is a form of revolving credit. Once approved, you will be able to borrow up to a set limit, in restricted increments. Some lenders will charge membership or maintenance and transaction fees every time you draw on the line. The interest is usually variable and the repayment term is usually fixed.

Before you decide on the type of second mortgage, first determine if you really need one. Both come with fees that can cancel out your potential savings. If you spend more than you make, tapping out the equity in your home to pay off consumer debt is a short-term solution that can put your home in jeopardy of foreclosure. Many people get into trouble by using their home equity to pay off unsecured debts, then running up the credit cards again. That pattern leads to a very difficult situation: no home equity, high debt, and the inability to make payments on both secured and unsecured financial commitments.

Refinancing Your Mortgage
Refinancing is the process of paying off an existing loan with the proceeds from a new loan, and using the same property as collateral. Because the interest rate on the new mortgage is less than the old, the loan costs less and you save money. The reduced interest rate decreases your monthly mortgage payment and frees up cash for other expenses – including debt repayment. Every percentage point makes a difference. For example, if you refinanced a $200,000, seven percent interest loan to a loan with six percent interest, you’d have about $130 more in your pocket each month.

If you only have a few years left on your mortgage and want to lower your payments, you can refinance the loan. While a new, longer-term mortgage will cost more in the long run, it can free up cash for to pay off high interest debt today. You can also refinance if the value of your home has increased, since it allows you to pull out the equity to pay for bills, while reaping the tax benefit. As with all mortgage related options though, make sure you are in a secure financial position before refinancing – you never want to put your principal residence and greatest asset in jeopardy.

To determine if refinancing will work in your favor, you’ve got to weigh the savings in interest against the fees associated with refinancing. These costs can be high, and some lenders require at least a portion of them be paid at the time of application. In many cases you have to have a good credit rating too.

Debt Consolidation Loans
Another possibility you may have is consolidating all or some of your debt into a new loan. Many financial institutions offer unsecured loans that can cover at least some of what you owe. The advantage is that you can bundle your payments, making it easier on your money management system, and if your credit standing is good you may be able to get an interest rate that is less than what you currently have. However, if it isn’t, be prepared to pay more.

Be aware that many consolidation loans charge a service fee, and as with home equity loans and lines of credit, if your expenses exceed your income, a debt consolidation loan is just a short-term solution that may not benefit you in the long run.

Borrowing from a Retirement Plan
If you have money saved in a retirement plan, you may withdraw funds to pay down debt, though it will result in an expensive tax consequence and costly penalties. A better option could be borrowing from your retirement fund. Most plans offer loans against contributions of up to half of your vested balance, with a $50,000 limit. Interest rates are usually much lower than those for the average credit card. Be aware though, that, if you leave your job, the remaining loan balance will be due immediately. If you are unable to repay the loan, the IRS will consider it as an early withdrawal.

Debt Management Plans (DMP)
A DMP is arranged by a credit counseling agency during a thorough financial counseling session. It is an arrangement where you make one payment to the agency, and they distribute the money to your creditors. During the repayment period of between three to five years, you are required to suspend use of all of your credit lines.

DMPs are beneficial because many creditors reduce or even eliminate interest rates and fees, so less money goes toward finance charges and more goes to the principal. Payments remain consistent, and as each debt is paid off, the remaining creditors are paid more, making it a very efficient system. And because it is a single monthly payment rather then several spread out over the month, clients often find money management easy.

To know if the DMP is right for you, a counselor will first examine your assets, income, spending habits, and debt. If there is enough money left over after paying your essential expenses to pay your debt on the DMP, then it is one of your options.