How Not to Pay off Debt: Dangerous Strategies to Avoid

Debt is a messy business and debt payoff strategies can be just as messy. If you’re not careful, these strategies can do untold damage to your credit score, drastically reduce your cash flow, and make life very difficult for you. It could take years to recover and, in some cases, you may be worse off than when you started.

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But what are these dangerous strategies, what sort of damage can they do, and what are the clean and effective ways to pay off debt?

Dangers of Taking Risks to Pay off Debt

When you’re heavily in debt it can feel like you’ve hit rock bottom, at which point it’s not possible to sink any lower. But that couldn’t be further from the truth. Your credit score can plummet further, your assets can be seized, your wages can be garnished, and you could be left with multiple collection accounts, a plethora of derogatory marks, and no option but to declare bankruptcy.

If that’s not the position that you’re in right now, you haven’t hit rock bottom and you need to take great care to avoid doing so. If you take unnecessary risks when paying off your debt, you may destroy your credit report for years to come. If you have a house, you could lose it; if you don’t, you may struggle to buy one.

Your credit score is one of the most important things that you have and taking risks will put it in serious jeopardy.

Why is it Important to Pay off Debt?

You may be surprised (and happy) to know that most debts have a statute of limitations. As an example, if you live in New York and don’t pay credit card for 6 years, you will no longer be legally obligated to do so. By that time, the debt will have been sold to a collection agency for cents on the dollar and while they may still harass you for payments, their hands are tied everywhere else and they can’t sue you.

In another year, that time-barred debt will be a thing of the past as it will disappear off your credit report and no longer impact your credit score.

But it’s not quite that easy and there are numerous complications along the way. Failure to pay your debts can start the dominoes toppling and trigger some very unfavorable outcomes

  1. Derogatory Marks: All missed payments will show on your credit report and the more of these you miss, the more your score will drop.
  2. Debt Collectors: Once the lender grows tired of chasing your debt, they’ll sell it to a collection agency, which will then try their hardest to collect from you. They will hassle you and try to get you to agree to a repayment plan or settlement amount.
  3. Reduced Rates and Opportunities: By this time, your FICO Score and VantageScore will have dropped so much that you’ll struggle to get a mortgage, car loan, or low-interest credit card. You’ll be forced to settle for high-interest credit cards and loans and maybe refused outright.
  4. Job Opportunities: Your credit report impacts more than just your chances of getting a credit card, personal loan, and mortgage, it may also prevent you from getting a job or security clearance.
  5. Lawsuits: There is a general assumption that your creditors won’t sue for small and insignificant debts, but this is a dangerous assumption to make. They can sue you for any amount of debt and if they get a judgment against you then they could garnish your wages.

And that just applies to credit card debt. If you don’t pay your taxes, you could end up with a prison sentence and even bankruptcy won’t clear them in their entirety. As for secured debts, failure to pay could result in repossessions and foreclosures. And that leaves us with medical debt, which is the number 1 cause for bankruptcy in the United States and can absolutely annihilate your finances.

What are the Most Commonly Taken Risks to Pay off Debt?

Some of the most commonly taken risks used to pay off debt include:

  • Intentionally Missing Payments: We’ve already discussed how much damage missed payments and defaults can do to your account, so why would debtors willingly subject themselves to this? One of the main reasons concerns the debt settlement process. Many settlement specialists require the debtor to skip payments so they can use that money to negotiate settlements. It has its benefits, but it’s also very risky.
  • Using Unscrupulous Companies: There are a lot of scam companies out there and they rely on desperation and greed. If you’re not careful and don’t do your research, you may lose your money and credit.
  • Acquiring More Debt: Debt consolidation is effective; we’ll discuss just how beneficial a debt consolidation loan can be soon. However, that doesn’t mean you can get the same results by acquiring new debt to pay off old debt. You could end up with more problems than you began with, especially if those new accounts are credit cards.

Long-Term Effects of Dangerous Debt Payoff Strategies

All debt payoff strategies can be dangerous if you don’t know what you’re doing, or you’re not prepared. That doesn’t mean that these methods are ineffective, it just means that you need to be very careful about the method you choose:

Debt Snowball and Debt Avalanche Method

These methods are very effective at clearing credit card debt and we’ve discussed them extensively in the past, including in our guide to the Debt Snowball vs Debt Avalanche. The latter of these two methods focuses on the highest interest debt first, requiring you to put all extra money you have towards this debt until it has cleared.

Debt snowball works in a similar way, only your extra money goes towards the smallest debt. Debt snowball can be problematic for users who have large, high-interest debts as well as a few small, low-interest ones. If you focus your extra payments and attention on those small debts, you’ll neglect the big ones doing the most damage.

This strategy still insists that you keep making payments on all debts, so it shouldn’t trigger defaults, but it can divert your attention from the most important and damaging debt and that could prolong your misery and increase the total interest you pay over the term.

Debt Consolidation Loan

Debt consolidation works by consolidating multiple debts into one, decreasing your monthly payment and improving your debt-to-income ratio. However, while consolidation is often seen as a win-win, debtors rarely acknowledge the vastly increased loan term, which increases the total interest paid over the lifetime of the loan.

So, while you may pay a few hundred dollars less per month, you could also be making repayments for 5 or 10 more years, adding thousands to your total balance. Debt consolidation, when used in the form of debt management, also requires you to close credit cards and keep only a single card active for use in emergencies. This can impact your credit utilization score and reduce your FICO Score.

Balance Transfer

Also known as credit card refinancing, a balance transfer moves all debt from one or more credit cards to a new card, taking advantage of the 0% introductory rates that these credit cards provide.

The idea is that you can use this interest-free period to accumulate money and then put that money towards clearing the balance. Credit cards are expensive because the interest is compounded. These cards negate that issue and give you a great opportunity to clear your debts.

However, those great rates come with a costly fee, often charged as a percentage of the balance. They also have higher interest rates and penalty rates and if you don’t clear your balance when the introductory period ends, this APR kicks-in and you may be in a worse position than when you started.

Debt Settlement

Debt settlement is one of the most effective debt payoff strategies, especially for debtors with collections, missed payments, and other derogatory marks. It is often undertaken by a settlement company or specialist who negotiates with the debtor’s creditors, agreeing to a settlement amount that is paid as a lump sum in exchange for the debt being cleared.

This sum is often between 40% and 60% of the original debt and even when the company’s fees are added the debtor still stands to save a lot of money.

So, what’s the issue? Well, for one thing, the settlement companies often ask the debtor to stop meeting monthly payments and then use this money to increase their leverage in the negotiations. The process can also take several years and if debtors have ignored their obligations in this time, they could face all kinds of legal issues, not to mention a severely damaged credit report.

Safe Alternatives to Dangerous Debt Payoff Strategies

Effective debt payoff strategies are the same as the ineffective ones—it’s all about how you approach them, whether you’re educated on the risks and the benefits, and whether they are right for you.

There are a few things you can do to improve your chances of these strategies working for you:

Deal with Regulated Companies

You can use the NMLS Consumer portal to find legitimate companies in the financial sector. This sector is rife with scams and uncertified companies that are only interested in taking your money. There are more legitimate companies than illegitimate ones, but it’s still important to do your research.

Scammers tend to make promises that they can’t keep, such as giving you access to a “special” government program that no one knows about or promising to deliver fast and guaranteed results. These promises get your attention and play on your desperation, but a legitimate company will never make a claim like this and will be very honest about the risks and uncertainties involved with any form of debt relief.

Speak with a Credit Counselor

Debt settlement companies offer free credit counseling in the first instance and you can use this to determine if their process is right for you. However, a large number of these companies, including some of the biggest names in the industry, employ pressure selling techniques and will push you to sign even if they know the process is not right for you.

To get the best and most honest advice, speak with an independent credit counselor. 60 minutes is all it takes for a legitimate, experienced financial expert to give you advice about your financial future. Be honest with them, tell them how much you earn and spend and how big your debts are—they’ll recommend the right way for you to pay off debt. 

Budget and Save

All debt relief strategies work better when they are backed by a strong income and a large bank account. This is essential for debt settlement, for instance, but it can also make life easier for you during a debt management program.

Prepare for this process by tightening your belt, reducing your outgoings, and putting any extra money you save into a separate bank account, Once you’ve determined the right payoff strategy for you, this money can be put to good use and will help immensely in clearing those debts.

Why is a Debt Management Plan Better than Debt Consolidation?

Debt management is ideal if you’re struggling to meet your minimum payments and have growing debts. It’s a form of debt consolidation whereby an experienced credit union or credit counseling agency will assume control of your debts, clear them, negotiate reduced monthly payments, and then distribute your money.

You pay them every month and they use that money to ensure your credits get what is owed to them. Debt management typically comes with very favorable rates and makes the process much easier for the debtor.

Debt consolidation works in a similar way, but you will pay much more money over the long-term and may face higher interest rates and monthly payments.

Both options can deliver a short-term hit to your credit score and both will do serious damage if you don’t keep up with your payments. They’re only beneficial if you stick to the agreed terms. 

Which Companies Offer the Best Debt Consolidation Options?

We have discussed this extensively in the past. You can visit our guide to Debt Consolidation Companies to learn more and see how the biggest companies in the industry compare. 

Generally speaking, many banks and credit unions will provide some form of debt consolidation, but the best companies are those that specialize in this industry and offer specific consolidation loans, ones that have low-interest rates, longer terms, and are willing to pay higher amounts to individuals with lower credit.

What are the Best Debt Payoff Strategies?

The best strategies for you will depend on the size of your debt and your income, as well as your ability to make your payments every month. Here is a quick rundown of the best strategies for different types of debt:

Student Loan Debt Strategies

Student loan debt is crippling young US consumers and accounts for a huge percentage of total consumer debt in the United States. However, there are many options available to a debtor when it comes to student loan debt, much more so than any other type of debt.

  • Forgiveness: Federal student loans qualify for numerous student loan forgiveness programs, including those aimed at public service jobs. You need to meet a set of criteria concerning experience, salary, and total loan repayments, but there is a multitude of options available.
  • Refinancing: If you can’t meet your loan repayments then contact your loan servicer and discuss your options. They may initiate a grace period that allows you to take a break or discuss refinancing options.
  • Consolidation Loan: Student loan debt can be consolidated just like any other loan debt. If you have private student loans this is a little trickier and potentially more expensive, but if they are federal loans then there are a multitude of federal programs to help you.

Credit Card Payoff Strategies

Unsecured debts are always at the back of the line when it comes to claiming from debtors. They will employ aggressive tactics to convince you to pay, but their options are usually very limited.

  • Debt Settlement: Although this process can get messy, it’s also ideal if you have a lot of credit card debt, many missed payments, and several collections. Debt settlement companies negotiate with your creditors and offer them lump-sum amounts to settle your debts for up to 60% less. They only take their fee when the debts have been settled, but you will need to cover the settlement fees by adding money to a secure account every month.
  • Balance Transfer: You’ll need a credit score of at least 600 if you have a chance of securing a decent balance transfer card. Once you do, you can secure cards with respectable interest rates and long 0% introductory periods. Some of the better cards will even give you rewards.
  • Consolidation: Loans have much lower interest rates than credit cards on average, so finding a loan that can clear all of your debts and leave you with a favorable rate shouldn’t be difficult. There are multiple companies out there that can help you with this.

Loan Payoff Strategies

If your loans are secured, your options are limited as they can just take your asset. If they are unsecured, however, then they work much like credit cards.

  • Snowball: The debt snowball strategy is great for loans because the interest rates are usually very similar and as you clear those smaller debts the bigger ones will become more manageable. Just use all additional funds you have to pay smaller debts while continuing to meet minimum payments on all other debts.
  • Consolidation: This process works with all forms of debt, but it is perhaps easiest with personal loans, providing you don’t have secured loans and your balance isn’t too high. 

Summary: Take it Easy

Debt payoff strategies are not evil and there are very few strategies that can cause serious harm (unless we include bankruptcy, which is akin to waving a white flag and isn’t an actual payoff strategy). However, if you go in blind, don’t do your research, and assume that all strategies are equally effective and safe, then the problems begin.

Now that you know which strategies to avoid, take a look at our guide to the most effective debt payoff strategies and start saving towards a cleaner, safer, financial future today.