Top 10 Debt Reduction Mistakes

May 28 2007

When faced with overwhelming debt or a looming crisis there are some classic mistakes that people often make. Here are the top ten debt reduction mistakes..

1. Ignoring your debt

Unfortunately for a lot of people, instead of confronting debt issues head on, we are likely to become deflated and demoralized, and then bury our head in the sand. The more we put off the inevitable, believing things are “not that bad” and it we will just work through it, without having to really exert ourselves to “solve” our debt “problem”. The more the once solid ground beneath our credit score feet comes to look alot like quick sand.

2. Getting taken in by unsolicited email promises

Taking advantage of vulnerable people. Scams that take you further into debt with huge penalty interest rates, or just plain HIGH interest rates from the start. Do not get me started on direct mail spam lending. It is pretty low stuff.

3. Consolidating credit cards onto a home mortgage

Unless you fix the underlying reasons why you are in debt in the first place.. remembering here we are not talking about GOOD debt like leveraging to invest.. we are talking here about BAD debt.. the kind of debt where the slogan “credit is the party, debt is the hangover” applies.. you will just be keeping yourself afloat and postponing dealing with the problem.

In theory re-financing is a great idea.. getting the debt onto a lower interest rate. But, as mentioned above, you need to address the habits that lead to that “maxed out” credit card, or 2nd personal loan to cover the payments on the 1st personal loan.

4. Reducing costs without a plan

Panic is what this point is about. You need to make sure you have a systematic plan to deal with overwhelming debt. If you try to make snap decisions to cure your situation you will likely make costly mistakes. You need to sit down with a budget and plan.

5. Trying to please everyone

When your debt situation is overwhelming you need to prioritize your bills. If you cannot afford to pay all your bills and you try to pay some one month and some the next, switching your payments around trying to keep everyone happy, you will end up displeasing them all.

6. Bypassing annual checkups

In the war to cut costs and save money, one of the things that seems to be discarded are the regular checkups. Whether with the local doctor or car servicing. This is certainly a mistake and sets you up to get hit with a MASSIVE medical or other type of bill, and sets you up to get hit unawares.

7. Opening new accounts for better rates

Again, same as with re-financing on to the home mortgage alot of people will try to solve their debt problems by moving debt from one account with a higher interest rate to one with a lower (credit cards are the classic example here). And again the problem is whether the underlying issue has been addressed. If not you just end up with another credit card maxed to the limit.

8. Closing credit card accounts

Another classic solution that people think is the way to solve their debt problems. Cut up your credit cards. Unless you have no self control this is a mistake. For two good reasons:

Pic thanks to Obex
1. Emergency fund. If you destroy your credit card you are forced to build up a cash reserve as your emergency fund. As you no longer have access to the paid off portion of your card in an emergency. This impedes you ability to pay off your debt as you need to divert money you could have been using to pay off your debt.

2. Credit Score. By closing your credit card accounts you can hurt your credit score by making your debt ratio seem higher, and shortening your credit history. (read more about credit score –> here)

9. Not knowing your rights

You should know your rights well at all times when it comes to your money, but especially so when you are in debt. And you shoudl never be naive enough to consider that debt collectors always play by the rules. You can check your rights and responsibilities –> here at the Federal Trade Commission web site.

10. Not knowing forgiven debt is taxable

Most people do not know that if part of their debt is forgiven, that will be reported to the IRS and is taxable if it is over $600. This is another example of why you need a plan. If you are not prepared your repayment problems are not cured by forgiving the debt, rather your problems are just shifted to Uncle Sam.