The start of a new year is a time when many of us make resolutions to improve our lives. One common resolution involves getting out of debt, which is a positive improvement in most people’s lives. However, there are some pitfalls in the strategies people often apply to resolving debt. As bankruptcy attorney I have seen many clients make diligent well-intentioned attempts to resolve their debt problems only to find that in the end they’ve made the situation worse. Below are two of the most common scenarios I sometimes see:
Using Home Equity to Payoff Credit Card Debt – The rationale in using home equity is usually that home equity loans have lower interest rates than credit cards. While this is usually true, the lower interest rate may not be worth the cost. In Florida, unless you agree to a mortgage, your homestead is protected from being seized to pay your debts. With a home equity loan you agree to give up that protection. A home equity loan is a line of credit where you’ve pledged your house as security or collateral to guarantee the debt. Whereas, credit cards are generally unsecured lines of credit. When you use home equity to pay off credit card debt you’ve taken a protected asset, your house, and placed it at risk. This means that if at some time you become unable to pay, the lender can foreclose on your home. Even if you later decide to file for bankruptcy protection, in order to keep your house, you must pay the debt in full.
Using Retirement Savings to Payoff Credit Card Debt– The other mistake I often see people making with regard to credit card debt is to use their retirement savings. Funds kept in a retirement account, similar to home equity, are protected funds that cannot be claimed by a creditor. So many times I’ve met with people who tried to resolve their burgeoning credit card debt by taking money out of their retirement accounts only to find the debt unresolved and their retirement savings gone. This not only leaves the person without retirement savings, but it also means that they’ve lost the years of interest and growth needed to fully fund their retirement.
There are effective methods for dealing with debt and a good debt management strategy is not a one size fits all program. The first step is often taking a financial inventory of debts and assets. Careful and accurate budgeting can often reveal opportunities for savings and provide valuable information regarding the relationship between income and expenses. For those who are struggling with debt that continues to grow or cannot be paid-off in a reasonable time while maintaining an acceptable lifestyle it may be beneficial to speak with a professional such as an accountant, financial planner, or a bankruptcy attorney. Having a plan that doesn’t involve additional borrowing is often the best method. I believe a good financial plan not only controls spending, but also includes a plan for increasing income through proactive career planning. The most important thing to remember is that knowledge is power. To be successful financially, you have to know where you are currently, what’s happening in your financial life, where you want to go, and then you plan how to get there.
I look forward to 2016 and the many adventures and challenges it will bring. I hope that your dreams for the coming year are all realized.