7 Bad Ways to Pay Off Debt (and What to Do Instead)

Paying off debt is a great goal, whether you have credit card balances, student loans, or another type of debt. Once you’re finished, you don’t need to pay expensive interest charges anymore or find money in your budget for debt payments.

Any effort to reduce your debt is commendable. That includes doing it yourself or with a debt relief program if you need a helping hand. But there are bad ways to pay off debt that could actually do more harm than good.

Bad debt payoff methods include anything that makes your financial situation worse. Some methods could increase your interest rate or your total debt. Some could put your home or retirement at risk. Many of these methods can keep you in debt even longer. These debt payoff methods may seem like a way out in the moment, but in the long run, they usually cost you more.

Here are the tactics to avoid as you pay off your debt. If you were considering any of them, don’t worry. For each bad way to pay off debt, there’s a better alternative. We’re going to cover those, too, so you can find your path to being debt free.

1. Taking a Payday Loan

At first, a payday loan might sound like a convenient way to tide you over until your next paycheck. You get the money you need now, normally with no credit check. On payday, you pay back your payday loan plus interest.

This type of loan seems like a quick fix, but it almost always costs far more money. Payday loans are predatory, with sky-high interest rates. Lenders typically charge $10 to $30 for every $100 you borrow, according to the Federal Trade Commission (FTC), and the usual term is just two weeks.

You could end up paying what amounts to an annual interest rate of 400% or more. In some cases, payday loan rates have even been known to surpass 1,000%. Borrowers don’t always realize how much payday loans truly cost because they only see the fees every two weeks, not the annual rate.

To make it even worse, most people can’t afford to pay back their payday loans in full. The Consumer Financial Protection Bureau (CFPB) found that over 80% of borrowers roll over their payday loans. When you roll over a payday loan, you only pay the interest charges, not the amount you borrowed. The lender then extends your loan another two weeks with the same excessive interest charges. If nothing changes, you could be trapped in this payday loan cycle for months.

Many states have regulations to reign in payday lenders. These regulations can limit loan amounts, interest rates, or terms. Here are a few examples:

• California puts a $300 limit on payday loans and limits fees to $45. Payday lenders also can’t make a new loan to pay off an existing loan.

• Georgia and Hawaii prohibit payday loans.

• Oregon limits payday lenders to a 10% loan origination fee, up to a maximum of $30, and annual interest rates of up to 36%. Payday lenders can’t roll over loans more than twice. Payday loans must last at least 31 days and no longer than 60 days.

But some payday lenders get around these regulations. For example, lenders affiliate themselves with Native American tribes and offer online payday loans. Because of tribal sovereignty, state laws don’t apply. Even if your state has rules in place governing payday loans, those rules might not apply if you get a loan online.

What to do instead

Open an account with a credit union that offers payday alternative loans (PALs). A PAL is a short-term loan from a credit union, typically with a much lower interest rate than a payday loan. You generally need to be a member of the credit union for at least three to six months and have direct deposit set up there to qualify for a PAL. Exact requirements depend on the credit union.

The banking app Chime also offers a payday advance service. You may want to check it out if you’re looking for an online bank instead of a credit union.

You May Like These

What are Credit Card Debt Relief Programs?

Statute of Limitations on Credit Card Debt

How to Not Stress about Money: 4 Key Tips

2. Using Credit Cards to Pay Other Debts

Moving debt to a credit card might look like a good strategy. One of the most common ways to do this is with a balance transfer offer. You transfer debt to your credit card, and that debt gets added to your card’s balance. Some credit cards even have a low introductory interest rate on balance transfers to encourage you to bring over your debt.

This approach is dangerous because it gives you the illusion of progress. You may feel like you’ve taken a step toward getting out of debt. In reality, you’ve only shuffled around your debt from one account to another. You haven’t addressed the root causes of how you got into debt in the first place.

Without doing that, you could continue to end up in the same situation. Some people transfer debt from card to card each time their introductory rate ends. Cash advances are another option to pay off debt with a credit card, and they’re arguably even more dangerous. Credit cards almost always have cash advance fees and higher interest rates on cash advances. Instead of paying down debt, you may eventually need credit card debt relief.

What to do instead

If you don’t have the cash to pay all your bills, you may need to prioritize certain bills and let others go unpaid. For example, you could prioritize your mortgage payments so your home isn’t at risk, while maybe not paying a store card or other unsecured debts. Then, you could talk to a Debt Consultant about debt settlement.

3. Making an Early Withdrawal From Your Retirement Account

Retirement savings, such as a 401(k) plan, are practically a must-have. Social Security benefits replace about 40% of pre-retirement income, on average. You’ll be more comfortable financially if you can supplement that with your own savings.

You may be tempted to pull from your retirement savings to pay off debt. But there are consequences to withdrawing money before you reach retirement age. With retirement accounts, you generally pay hefty taxes and an early withdrawal penalty if you take out money before you reach age 59 1/2. You’d be forfeiting a large amount of your savings, which is why early withdrawals from a retirement account are near the top of the list of bad ways to pay off debt.

What to do instead

Try other options for repaying debt, including debt negotiation, debt consolidation, or professional debt help, so you don’t need to touch your retirement accounts.

4. Skipping Tax Payments

It’s never a good idea to run afoul of the IRS or state tax authorities. When you don’t pay your taxes, you could incur interest charges and penalties on the debt, have your wages garnished, or even face jail time in a worst-case scenario.

What to do instead

Talk to an accountant, tax attorney, or tax debt resolution firm. These professionals might be able to negotiate a lower payment or set up a payment plan for your taxes or your other debts. The IRS ultimately just wants you to pay your taxes and is likely willing to work with you to find a suitable arrangement.

5. Extending Student Loan Repayment Timeframes

Student loan debt can be costly, because even if the interest rate is low, many borrowers have a large amount of debt. If you stretch student loan repayment too far, your debt will rack up more interest charges. You could still be making payments when you’re close to or even in retirement. You also can’t easily discharge student loan debt in bankruptcy like you could with credit card debt, personal loan debt, and other types of debt.

What to do instead

If you can't pay your student loan, contact the lender or servicer immediately to learn about your options. But be cautious of deferment programs that prolong the debt substantially.

6. Rolling Over an Auto Loan

If you want to buy a new or used car, but you haven’t paid off your current vehicle, auto dealers normally let you roll over an existing auto loan. You trade in your current car, and the dealer adds the balance from the old loan to the new one.

Because you’re borrowing even more money, while you still owe money on your last car, you could go deep into debt this way. You’ll also likely be upside down on your new car, meaning you owe more money than it’s worth.

What to do instead

Pay off your car loan before you consider getting a new vehicle. Even better, drive your current car for as long as possible and resist the temptation to upgrade. When you don’t have a car payment, you’ll have more money to use elsewhere in your budget.

7. Borrowing Against Your Home (if the Cause of the Debt Is Still Present)

If you’re a homeowner, you could use a home equity line of credit (HELOC) to pay off debt. A HELOC is an option when you have positive equity in your home, meaning the amount you owe is less than what your home is worth. For example, if you owe $200,000 on your mortgage, and your home is worth $250,000, you have $50,000 in equity.

A HELOC isn’t always a bad way to pay off debt, but it has risks. If you have unsecured debt, such as credit card debt, paying it off with a HELOC turns it into secured debt. Secured debt has collateral attached—in this case, your home. The lender could foreclose on your home if you don’t repay your HELOC.

The upside of a HELOC is that you could get a lower interest rate on your debt. But don’t forget to weigh the HELOC’s closing costs and fees against your potential interest savings.

Because of the risks involved, a HELOC usually isn’t a good move if you haven’t fixed the cause of the debt. For example, if you overspend on credit cards, paying off your cards with a HELOC doesn’t fix the underlying issue. It also puts your home on the line for your debt.

What to do instead

Take an honest look at the reasons you’re in debt. If you had a costly divorce, medical issues, or a job loss, then a HELOC could be a good strategy. In those situations, your financial habits didn’t directly cause your debt. On the other hand, if you’ve been spending above your means, you’re better off working on that issue instead of borrowing against your home.

Whatever type of debt you’re trying to pay off, think about ways to find money for those payments. Can you take on an extra job? Get a roommate? Cut down on eating out? Your future self will thank you for making sacrifices today, rather than choosing any number of bad ways to pay off debt that could hinder your future.

Warning Signs You’re About to Make a Bad Debt Decision

Dealing with debt can be an emotional rollercoaster. It’s probably on your mind often, especially if you’re getting calls from debt collectors. You may find yourself feeling worried, guilty, or anxious to do something about your debt, even if you’re not sure exactly what it is you should do.

These kinds of emotional triggers can lead to poor choices. The best debt decisions involve strategic planning. You evaluate your situation, consider your options, and think about which choice will benefit you the most over the long haul. When you’re under too much pressure, you could make decisions from a state of panic, which rarely works out well.

If you’re in a heightened emotional state, hold off on doing anything. Remember that you have time to figure out your next move. Give yourself at least one night to sleep on major financial decisions. You can read about the debt payoff method you’re considering and learn about alternative options so you don’t make a move that comes back to haunt you.

Consider All Your Options to Attack Your Debt

There’s no quick or free way to get out of debt. Get yourself mentally ready to do some work. It starts with an assessment of your full financial picture. Your bills, debts, and income all play a part in finding the right debt payoff strategy.

You’ll need a budget to see your cash flow—the amount of money you have left over after paying all your expenses. Check your most recent direct deposits or paystubs to find out your take-home pay. Then, go over your banking and credit card statements and make a list of your expenses. Subtract your expenses from your income to see how much cash flow you have that you can put toward your debt.

If you can afford to pay your debt, and you’re not late on any accounts, then you probably just need to decide how you’ll organize your payments. Two good methods to consider are the debt avalanche and the debt snowball. Here’s how they work:

• The debt avalanche prioritizes debt with the highest interest rate. You make minimum payments on all your debt, and put extra money toward the account with the highest rate to get it paid off as soon as possible. This method could help you save money on interest.

• The debt snowball prioritizes debt with the lowest balance. Once again, you make all your minimum payments, but you put extra money toward the account with the lowest balance. This method can be motivating, because you get accounts paid off as quickly as possible.

If money’s tight and you’re at risk of missing payments, call your creditors and ask about their hardship programs. Lenders and credit card companies are often willing to work with people who are in a jam. But it helps if you’re proactive and contact them before you miss any payments, not after the fact.

Even if you can’t make your payments, or if you’re already missed payments, you still have options. You may want to consider a debt relief program. This type of program works with you to reach a debt settlement with your creditors. When you don’t think you can pay back all your debt, settling it for less could be your best move. Learn how debt relief works for more on this method.

Credit counseling could also work, if you can afford to make a large monthly payment. A credit counselor can talk to your creditors and set up a debt management plan (DMP). A DMP generally lasts three to five years. You pay the credit counselor every month, and the credit counselor distributes the money to your creditors.

It’s also important to address the reason you went into debt in the first place, whether from overspending, a costly emergency, or something different. Reflect on what happened and the steps you can take to avoid going back into debt in the future.