6 mistakes to avoid when paying off debt
If you’re still burdened by debt, you may need the proper way to pay off debt. You’re probably trying to reduce your unpaid balances already. Unfortunately, the debts continue to accumulate. In response, you should reevaluate your payoff plans and check for these 6 mistakes.
First, it’s a good idea to plan your debt payoff carefully. Pay above the minimum, and always search for ways to facilitate debt payoff, including balance transfer options. After paying off credit card debts, keep your account open. Finally, build an emergency and retirement fund immediately.
Paying off debts properly helps eliminate them early. It allows you to allocate funds for more essential expenses to improve various aspects of your life. More importantly, financial literacy is an integral part of adulthood. Everyone should understand proper money management.
Not planning how to pay off debts
If you want to do anything properly, you need a plan. It’s especially crucial when you’re paying off debts. Without it, you’ll probably take too long to accomplish debt freedom.
There are different forms of debt, each with its terms and conditions. For example, medical debts charge little to no interest, unlike credit card debts.
You may adequately pay off debts using two methods: debt avalanche and debt snowball. The ideal choice depends on several factors, mainly your discipline.
Debt avalanche starts with debts with the highest interest rates. This would prevent the high-interest from accumulating excessively.
As a result, it’s a more reasonable method than the debt snowball. You’ll need patience, though, as you won’t see significant results right away.
On the other hand, the debt snowball method starts with your smallest debts. This lets you see immediate results from your debt payoff.
Though, you’ll probably take longer compared to using debt avalanche. If you have trouble sticking with a debt payoff plan, this is perhaps the better option.
Making minimum payments only
If you’re paying only the minimum every month, that could be delaying your debt freedom. As much as possible, your monthly payments should exceed that limit.
Minimum payments take too long to reduce your debt’s original amount. As a result, you’ll accumulate more interest and delay paying off debts completely.
We know that employment opportunities are rare during the pandemic. However, you may find a side hustle online to boost your earnings during the pandemic.
If not, you could find other ways to earn extra cash. This would let you submit payments beyond the minimum and complete debt payoff sooner.
Also, take advantage of government programs that ease debt payment. For example, President Joe Biden extended the zero-interest-rate moratorium for student loans.
In response, people with student loans should pay more during the interest rate freeze. Biden’s executive order allows them to reduce the principal directly.
Not checking balance transfer options
Banks and credit unions could help in paying off your credit card debts. For instance, they offer debt reduction methods such as debt consolidation.
It pays off multiple unpaid balances using a borrowed lump sum. In turn, it replaces your numerous debts with one that usually has a lower interest rate.
You may get a debt consolidation loan from your bank or credit union. They come as personal loans that combine different types of debt, such as student loans.
If you’re struggling with unpaid credit card balances, you may get a balance transfer credit card. You could combine them all in the card so that you could manage one balance instead.
What’s more, they have an introductory period with 0% APR. This allows you to pay off debts without interest in the way.
However, you must complete the payoff before the intro period ends. Otherwise, the card will charge a hefty interest rate, just like a regular credit swiper.
Closing your credit card after completely paying it
You’re probably tempted to close your credit card account after clearing its unpaid balance. However, it’s best to keep it open even though you aren’t using it.
Closing your credit card could reduce your credit utilization, a significant factor in credit rating. It’s one of the ways people unwittingly destroy their credit scores.
It’s the unpaid amount on your credit card divided by your credit limit. Closing your credit card lowers the limit, so you get a higher credit utilization.
Keep your credit utilization under 30% to get good credit. Besides keeping your credit cards, paying off debts on them helps lower your utilization.
Your credit score is vital for accessing numerous essentials for everyday life. You need it for buying a house, a car, or an education, and it’s also a requirement for employment!
By maintaining a low credit utilization, you keep a healthy credit score. More importantly, it makes sure you don’t miss out on essential products and services.
Putting off building an emergency fund
If you’ve procrastinated on setting funds aside in your savings account, that’s another debt payoff mistake. You should save money while you can, so you can handle emergencies.
You don’t know what could happen in the future. No matter who you are, unfortunate events could occur. You’ll need an emergency fund in case they happen.
The current pandemic just revealed how many Americans didn’t have emergency funds. Still, some people had emergency funds that helped them endure this crisis.
While paying off debts, you may accumulate extra funds. If you can, use them to start your emergency fund. Just make sure you don’t have other urgent payments.
You could use tried and tested budget plans like the 50-30-20 method. This could provide structure to the way you pay off debts.
Taking from your retirement fund early
If they can’t pay off debts, people may borrow from their retirement fund too early. After all, the latest stimulus bill removed the penalty for early withdrawals.
However, financial advisors strongly discourage taking from your 401k early. Here are some reasons for their disapproval:
1. You’ll have to spend more if you want to rebuild your retirement fund.
2. You’ll miss out on investment returns, meaning the fund won’t grow much.
3. It may lessen the funds you could allocate to your 401k account.
4. You might lose even more money. If you’re struggling with finances, you’re more likely to default on your 401k. It will turn into a withdrawal that may charge a considerable tax.
5. Early withdrawal resets the repayment clock if you lose your job. After leaving your employer, you have to repay it in a short time. Otherwise, this could also turn your 401k into a taxable withdrawal.
6. You may lose the retirement fund that could provide financial support in your later years.
7. Early withdrawal may encourage you to continue poor money habits. You might not evaluate them, so you won’t start paying off debt with better means.
Paying off debt is an essential aspect of proper money management. However, some people could be doing it incorrectly by making the 6 mistakes we mentioned.
Don’t just rely on our financial tips, though. You should check for more ways on how to pay off debts on the internet. After all, you might need information that wasn’t discussed in this article.
Everyone should learn how to manage their finances properly. Particularly, paying off debts successfully grants debt freedom, opening more opportunities in life.