Debt Repayment Options

The debt reversal pyramid is a method of paying off your debts faster than your current schedule. It can yield great results, but it only works if your payments are on time and you stop using the lines of credit that you are trying to repay. You must balance multiple payment schedules and it can be challenging. Make sure this is the right solution for you before you commit to it. Here is how it works:

• Review your monthly expenses and reduce them where you can. Create a budget that sets aside an extra amount of money every month to use to pay off your debts.
• List your debts (balances and payments) from smallest to largest. If your loan balances are all roughly the same, list them from highest interest rate to lowest interest rate. Pay off the loans with the highest interest rates first.
• Start with the first loan on your list. Include the extra sum of money that you set aside in step one, with every monthly payment.
• Once that loan is paid in full, focus your attention on the next loan on your list. Add the entire monthly payment from first loan: minimum payment plus extra amount to the monthly payment for the second loan.
• Continue working through your list. With patience and consistency, you can pay off your debts.

If the interest rate on your debt is high, using some of your savings to pay it off might be a good idea. For example, if the interest rate on your loan is 12%, you would have to earn more than 18% on your savings to justify not using it to pay off the loan. Weigh the pros and cons of this option carefully. Savings accounts are your safety net for periods of unemployment or underemployment, unexpected expenses such as home and car repairs or medical bills, and for protecting priority debts such as a mortgage or a car. If you can, keep a savings account to cover your priority debts.

Many consumers have some form of life insurance with a cash value option. This practice, however, should be considered only as one of your last results. Borrowing against these policies might be a good way to repay your debts. Essentially, you are borrowing your own money, but it is imperative that you pay it back. The interest rates are usually far less than the rates charged by credit card companies. The repayment period is usually set by the policy holder. Beware - if the balance has not been repaid in full before you pass away, the outstanding balance plus interest will be deducted from the face value of the policy. You will transfer the burden of your debt, in the form of a reduction in policy pay out, to your beneficiaries.

Borrowing against your home equity could be a quick fix, but it also carries the risk of using your home as collateral. If you are a home owner and have been faithfully paying your mortgage for some time, you might consider a Home Equity Loan (HELoan) or Home Equity Line of Credit (HELOC) to help you pay off your unsecured debts. This will help you reduce expenses in two ways. First, you will pay less in interest payments. The average interest rates charged for HELOC and HELoans are 6-7% versus the average 12-20% rates charged by credit card companies. Second, if you itemize deductions on your income tax returns, the interest paid on a HELOC or a HELoan is tax deductible (in most cases). If you are in a 25% marginal tax bracket, a 6% loan has an effective rate of 4.5%.

If you participate in a 401(k) qualified retirement plan at work you may be aware of a feature that lets you borrow up to 50% of the account's value, or $50,000, whichever is smaller. These loans usually have interest rates a point or two above prime, which is much lower than the rates typically charged by credit card companies. Since you are the lender, you are basically paying yourself back. That's right - every dime in interest paid on a 401(k) loan goes directly into the borrower's 401(k) account. 401(k) accounts are legally protected from your creditors and bankruptcy in the event of extreme financial difficulty.

As with any repayment method, there are drawbacks. Uncle Sam will double dip in your retirement funds. You will most likely repay the loan with after-tax funds, and the interest will be taxed again when you withdraw money from the 401(k). You must repay the loan within five years. This could be challenging depending on the job environment and the constantly increasing costs of everyday life. If you leave your employment prior to full repayment, the outstanding balance becomes due and payable immediately. If the loan is not repaid, the balance will be treated as a distribution and you'll be required to pay tax on the distribution amount. Furthermore, if you are under the age of 59 and one-half, you will be assessed an additional 10% excise tax as a penalty for early withdrawal of retirement funds.

In tough financial times, consumers generally resort to whatever means possible in an attempt to stay afloat. In some cases, that means turning to a trusted friend or family member for support. After all, there isn't anybody that knows you and trusts you as well as family and close friends. In order to prevent these relationships from souring, it is best to have a plan and set reasonable terms prior to the exchange of funds. Friends and relatives may even tolerate a late payment or two if times get even tougher. However, if you want to maintain the relationship, its best have a written agreement. You should establish the interest and repayment schedule in writing to avoid misunderstandings and hard feelings. You must be scrupulous about adhering to the schedule out of respect for your friend or family member's sacrifice. Pay on time to keep their trust.

Make your creditors aware of your situation as soon as you identify a problem with your cash flow. Request a lower payment amount and a lower interest rate. Let your creditors know that if you are unable to renegotiate terms, you may have no other option but to declare bankruptcy. When faced with that possibility, creditors will do what they can to protect themselves against a total loss. Renegotiating terms can save you some money and improve your cash flow situation. If you don't want to do the negotiating yourself, CCCS of Chattanooga can do it for you.