Cash and Debt ManagementPaying Off Your DebtWhen people think of paying off their debts, the first thing that comes to mind is getting a large debt consolidation loan and paying everything off with that. The problem is, you’re still left with DEBT. The remainder of this information will focus on ways to borrow, but you should first ask yourself is there another way?
Alternatives
- You need to keep enough cash for three to six months of emergency money, but if by chance there’s more, think about using that.
- Are there assets you can use? You may have some savings bonds, or some stock options, or an inheritance. Do think carefully before you use long-term assets to pay debt, however. You may need this money in retirement.
- Are you making payments on things you don’t really need? Do you have to have a $30,000 car when a $15,000 one will get you to the same places? Do you need that fancy stereo? Consider selling the things that aren’t really necessary.
- Could you take a second job temporarily, and use the money from that to make extra payments on your debt? What about your spouse or your older children?
HOT TIP! There is a Catch-22 that many people face when looking to dig out of debt: the more you owe, the tougher it is to borrow, and the higher the interest rate you pay. Your goals should be: 1) to MINIMIZE the interest you are paying, net of tax, and 2) to pay down the debt as quickly as possible.
Types of Loans
If you do decide to borrow, below we list a number of different kinds of loans and the risks associated with them. You can’t borrow money without risk. All of these types of loans can be used for the purpose of consolidating your debts.
Source: If you have equity in your home, that’s a logical place to look for funds. The interest rates are usually reasonable on home equity-loans and lines of credit, and the interest is tax-deductible on loans of less than $100,000. Risk: If you can’t pay the loan back, you risk losing your home.
Source: Refinance your first mortgage. The interest rates are usually favorable and the interest is tax-deductible. If market rates are lower than your current mortgage rate, consider it. Risk: Same as above.
Source: Your company retirement plan. You are borrowing from yourself, and usually paying yourself back at the prime rate, or close to it. Risk: You limit your return to the prime rate, and if much of your retirement plan money is in the stock market, you may be giving up quite a bit of gain. There is also the risk of not paying the loan back, and jeopardizing your retirement.
Source: Permanent life insurance. The interest rate varies depending on the company, as do the fees. How much you can get depends on the cash value in your policy. Risk: If not repaid, death benefits may be reduced.
Source: Personal loan. May be secured or unsecured. Interest rates tend to be high. Risk: Getting further behind the 8-ball with high payments.
Source: Credit cards. Risk: Interest rates up to 22%. Temptation to run up debt further.
Source: Family and friends. IRS will generally require you to impute interest at prime. Risk: Putting severe strains on the relationship.
Interest Rate Example
To show you the difference interest rates can make, let’s look at two $10,000 loans:
| Principal |
$10,000 |
$10,000 |
| Interest rate |
22% |
7% |
| Number of years |
5 |
5 |
| Monthly payment |
$276.19 |
$198.01 |
| Total payments |
$16,571 |
$11,881 |
HOT TIP! Treat your debt like a term loan, even if it’s open ended. If you have to pay off $20,000 in total, for example, you could pay it off over 5 years by paying $425 per month at 10% interest. You could pay it off over 10 years by paying $264 per month at 10%. The higher the interest rate and the shorter the term, the larger the payment.
Paying Your Debt To Uncle Sam
It’s hard to pay your taxes when you’re trying to make ends meet. In most cases, back taxes are generally NOT ‘dischargeable in bankruptcy.’ That means that you will still probably have to pay your taxes... bankruptcy doesn’t get rid of them. If you DO go through bankruptcy, there will be a hold, or ’stay’ put on your taxes, along with all your other debts, while things are sorted out. But after that, priority tax claims, including taxes due within three years and tax penalties, must be paid. So let’s find a way to do it.
In the first place, no matter what your financial situation, always file your taxes. If you can’t pay the full amount, pay what you can. Otherwise, interest and penalties will compound, and late filing charges will be assessed. If you can’t pay the full amount when you file, you can ask to pay in installments. That is done by filing Form 9465, Installment Agreement Request. If you owe less than $10,000 and are willing to pay it off within 36 months, your request is normally granted. Otherwise, you need to contact the IRS and file another form, 433-A, Collection Information Statement for Individuals. The IRS will then either let you pay in installments or tell you to sell some of your assets to pay off the debt.
On rare occasions, the IRS will accept an Offer in Compromise (Form 656), which is an offer to satisfy your debt with a partial payment. You fill out a form that states your reason for not being able to pay the full amount. You must provide a financial statement. The IRS will look very carefully at your reasons and at your statement. If it is accepted, it may be under the condition that you will have to pay more if your financial condition improves.
Whether you have worked out an arrangement or not, your taxes should be your first priority in payment of debt. You can’t go to prison for leaving your credit cards unpaid (unless you committed an illegal act in doing so), but you can go to prison for nonpayment of taxes.
Article Content by Truebridge, Inc. All rights reserved. Copyright 2001-2010 |
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