Could these debt repayment strategies backfire?
Becoming debt-free is a great goal if you have high-interest consumer debt, because your loans and credit cards could end up costing you a fortune. But is there a wrong way to get out of debt?
If you listen to Dave Ramsey, there is. In fact, there are eight popular winning strategies that Ramsey does not recommend.
1. Debt consolidation
This technique involves getting a new personal loan or other type of loan and using it to pay off whatever you currently owe, leaving you with one monthly payment. If you can consolidate your debt at a lower rate than you’re currently paying, that’s actually a great technique.
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However, Ramsey doesn’t recommend it because he thinks it will set you back in your earning schedule. “It sounds like a good idea until you realize that your debt life is increasing, which means you’re in debt for longer,” he warned. “And the low interest rate that seemed so good at first usually increases over time.”
In reality, it all depends on the type of consolidation loan you get. If you’re swapping credit cards with extremely low payments and a decades-long payback period for a personal loan that you’ll pay off in a few years with a low fixed interest rate, it’s really hard to see why that would be a bad thing .
2. Debt settlement
It involves settling your debt for less than you owe. You can usually only do this if you are late on payment (which hurts your credit) and if you negotiate and get approval from your creditors. This option should be an option of last resort to avoid bankruptcy, so Ramsey is correct that it should generally be avoided except in limited circumstances.
3. Avalanche of debt
This is another error that Ramsey is wrong about. An avalanche of debt is an alternative to his snowball plan. These two plans dictate the order in which you pay off the debt. Ramsey’s snowball approach suggests paying off your debt with the lowest balance first, then settling the next lowest balance, and so on. Instead, the avalanche method is to start with the highest rate loan.
Ramsey simply explains his opposition. “The problem with this method is rooted in motivation,” he said. “Remember: Paying off debt is less about math and more about behavior. With the avalanche of debt, your first targeted debt can take a long time to pay off. But you need quick wins that encourage you to continue! The avalanche of debt also takes I can’t wait to see real progress.”
The problem is, you could end up paying a lot more if you have high-interest debt with a large balance and focus on paying off tons of cheaper loans first. There are other ways to stay motivated without costing you a fortune by paying off your debts in an order that makes no sense.
4. 401(k) loan
It involves borrowing for your retirement, and Ramsey says don’t do that unless you’re facing bankruptcy. He is right. You will miss out on the growth your investments could have generated while you repay the loan and there is a high risk that you will not repay the loan and it will be treated as a withdrawal, resulting in a penalty of 10%.
5. Home Equity Loan
Ramsey advises against this approach because “a HELOC trades what you actually own in your home for even more debt – and puts you at risk of losing your home if you can’t repay the loan on time.”
Ramsey is also right on this point. You would have to get a loan against your house and use the house as collateral if you took this approach. You don’t want to trade unsecured debt (like credit card debt) for secured debt. There is a huge risk involved.
6-8. Credit card balance transfers, personal loans and loans from family and friends
These are the other three winning strategies that Ramsey says to avoid. In each case, he suggests not doing so because you are exchanging one debt for another that could potentially be more risky.
Again, however, this ignores the benefits of these strategies. A credit card balance transfer allows you to transfer the balance from a high rate card to a card offering 0% interest for a period of time, while a personal loan can also be used to pay off debt credit card using a remote loan. lower rate. And a loan from friends and family can be entirely interest-free.
Ultimately, these strategies might make sense in your situation, just like the debt avalanche technique or a debt consolidation loan. So while it’s worth reading Ramsey’s objections to these approaches, you shouldn’t simply ignore them. Instead, it’s best to research them carefully to see if they make sense to you.
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