Getting out of a mountain of debt can often seem overwhelming, even impossible at times. The road to financial freedom and security may appear arduous, but those goals are within striking distance if you make a firm commitment to living within your means. Becoming debt-free and financially secure is possible with a disciplined plan and sound strategy.
But, at the same time, it is also important that you steer clear of some of the pitfalls and common errors most people make along the way. Getting a knowledgeable Arizona bankruptcy lawyer in your corner can help you overcome many of these challenges and most importantly, help you avoid a number of mistakes that can sabotage your plan to get out of debt and get your life back on track.
Here are the five major mistakes to avoid when you are trying to get out of debt:
1. Home Equity Loans: Never use your home equity to pay off credit card bills, medical bills or other unsecured debt. The bankruptcy lawyers at Pew Law Center recently met with a couple who took a $150,000 loan on their home equity to pay off their debt and help their children with financial issues. Now, they are retired and that home equity loan is finally changing to a fully amortized payment from an interest-only payment. What this essentially means is that their monthly payment tripled.
On a fixed income, they couldn’t afford the payment. We fully intend to find a workable solution for them. But if they had come to us before they decided to borrow on their home equity, we would have advised them to file bankruptcy to wipe away their debt. That way, we could have protected the equity they had in their home instead of them having to leave their home, which they worked so hard all their lives to keep.
2. Using Retirement Funds: Another common mistake we’ve seen people make while trying to get out of debt is borrowing or liquidating from their retirement, 401(k), or pension. People tend to forget that this money is for their retirement. You can raid this money now, but at what cost? First if you liquidate your retirement and get the cold, hard cash now, you will be taxed on those withdrawals.
The money you withdraw from your retirement accounts will be taxed as ordinary income. In addition, you may be subject to the 10 percent early withdraw penalty. Let’s say you take out $40,000 from your 401 (k) to pay off debts, you will most likely incur a $4,000 penalty. Also, you’ll have an income tax bill of $8,000 (assuming you have a 20 percent income tax rate). So, now you owe the IRS $12,000. Of course, this doesn’t include what you owe in state taxes. All you really have left to pay off your debts now is $28,000.
Many people don’t find out about the tax bill after they’ve already spent the $40,000. I don’t know about you, but I’d rather owe money to the bank rather than the IRS. I have met with a number of people who have raided their retirement accounts to pay off their debts, but are still in debt. Many did not have enough to pay off all their debts. To add to their headache, they are now left with an enormous tax bill. Or worse, now they are close to retirement age, but back in debt, with no money to support themselves during their golden years. It is heartbreaking to see individuals retiring with little to nothing in their retirement accounts, and still saddled with debt.
3. Underestimating the Problem: Many people think they can continue to get out of debt simply by making minimum payments. It’s important to understand that you simply cannot do that. Credit card rates, for example, are higher than most forms of debt. So, borrowing with a credit card will cost you much more than borrowing through another type of loan. Credit card interest rates average about 16.31 percent, according to Bankrate. But, there are also credit cards whose rates are upwards of 20 percent.
In addition, minimum payments for credit cards are often well below what you would need to pay off debt quickly and efficiently. Most credit card issuers require high-balance borrowers to only pay 1 percent of their total balance, plus their accrued interest and fees, every month. What many don’t realize is that this high interest rate combined with low monthly payments make credit card debt much more expensive. Never think your credit card payment is easily paid off without consequences to your credit history and your overall financial situation. You need to make a solid plan to get rid of your debt.
4. Not Getting Help: It’s a fact. Most of us don’t want to ask for help. Or we don’t know whom to trust. Some are not told the complete truth. Debt settlement companies don’t really help people. They don’t provide all the options available. If they did, they wouldn’t have very many customers. Debt settlement companies don’t inform you completely about the risks of still getting sued, collection calls, wage garnishment, and creditor harassment.
For example, let’s say you have a credit card debt of $10,000 and the debt settlement company negotiates a settlement of $6,000. You are released from the $10,000 liability for paying $6,000. What happened to the remaining $4,000? The credit card company will issue a 1099-C to you and the IRS. You may have to pay taxes on the $4,000 as income.
So you didn’t really get as good of deal as you thought. You were trying to save money, but in reality some of these companies cost you more than the debt. $6,000 + $800 (estimated increase in taxes) + $1,000 to $2,000 (the debt settlement companies fees) + trashed credit + 6 months to three years of your life waiting for the deal to go through = unwise financial move.
5. Misinformation and Stigma: For many people, bankruptcy is still a dirty word. They suffer from prejudice and fear when it comes to bankruptcy, or are simply not well-informed about it. One of the many reasons that people choose not to file for bankruptcy even if it would benefit them greatly is the stigma associated with it. This is extremely unfortunate because it prevents people from seeking out the best option to address their financial problems. Eventually, everyone needs to understand that bankruptcy is their legal right. It is a tool in your arsenal to help fix unfavorable financial situations.
If you are overwhelmed by debt and are wondering how to shore up your financial future, please contact the experienced Phoenix bankruptcy attorneys at the Pew Law Center to find out if bankruptcy might be an option for you. Call us at 480-745-1770 for a free and comprehensive financial strategy session.