Debt is a reality for many Americans. Consider the following statistics from consumer information provider ValuePenguin:
- The average amount of credit card debt in America is $5,700.
- More than one-third of all American households have credit card debt.
- The total outstanding U.S. consumer debt is $3.9 trillion.
Many individuals find themselves underestimating or ignoring their financial obligations in the hopes that their debt will disappear. While this choice may seem easy, it could delay or even prevent taxpayers from accomplishing many financial objectives. The following four debt management “magic tricks” can help address common obstacles to financial prosperity.
Debt Management Trick #1: Always Review Credit Reports
Many people glance at their credit reports, see a decent score, and move on. But credit reports often contain errors that present a false history of a person’s financial standing. Review the report regularly and follow up on any inaccuracies with the issuing credit agency. For example, make sure that the report does not mistakenly reflect a lower credit limit.
Debt Management Trick #2: Don’t Vanish All Credit Cards
Closing out credit cards may seem like standard debt management. However, eliminating them might not necessarily be the best idea. Instead, cardholders could do the following:
- Limit the number of open cards.
- Pay off the cards or maintain low account balances.
- Avoid or renegotiate high-interest rates.
The major credit-reporting agencies use a combination of metrics – including credit history and debt utilization (i.e., the ratio of debt to available credit) – to establish a person’s credit score. Closing out a card reduces credit history, limiting the data by which a person is evaluated and increasing debt utilization. Therefore, canceling a card could have detrimental effects on a credit score.
Debt Management Trick #3: Avoid Using Loans to Pay Debt
The easiest way to deal with debt may seem a broad, sweeping strike to pay it off. Unfortunately, gathering the funds to do so may only worsen the overall situation. For instance, home equity loans typically offer lower interest rates than credit cards and large available balances. Plus, the interest paid on a home equity debt may be tax deductible, while credit card debt generally is not. But the greater obligation is not really erased — only transferred. Furthermore, the borrower’s home could be at risk.
Similarly, taking out a 401(k) loan offers easy, low-interest access to funds. However, a significantly negative tax impact and marked reduction in one’s retirement savings are downsides. Additionally, interest paid on such a 401(k) loan would not be tax deductible.
While withdrawing from a 401(k) plan may seem like a simple solution, there are alternative methods of accessing cash that could help individuals settle their debt.
Debt Management Trick #4: View Bankruptcy as an Opportunity
Filing bankruptcy should certainly be the last resort of any debt management plan. However, taxpayers may want to look at bankruptcy as a last-chance opportunity rather than an outright failure. In many cases, a person’s credit score can recover surprisingly quickly from bankruptcy — sometimes as soon as three to five years. In addition, some tax liabilities that meet certain requirements may be discharged in bankruptcy.
Let CRI Help Make Your Debt an Illusion
Sound, timely advice from experienced CPAs can help you magically escape the burdens of unsettled financial obligations. Please contact us for guidance regarding how to best manage your debt and achieve your financial goals.