4 Foolish Ways to Handle Debt

All of us have it at one time or another, and we also want to get rid of it. No, it’s not a cold – it’s debt. As of the end of 2013, the Federal Reserve Bank of New York reports consumers have a combined total of $11.52 trillion in debt. This is more than 2 percent higher than the year before. However, we are slightly less indebted than we were in the third quarter of 2008, when total consumer debt hit a peak of $12.68 trillion.

Most of our debt stems from home mortgage payments, and the outstanding bill for those home loans is around $8 trillion. This accounts for loans on all homes, from the $80,000 rancher to the $5 million waterfront mansion. Our student loans account for a portion of our total debt bill, as well. At over $1 trillion, education loans are about 10 percent of the total debt bill. The remainder of our debt stems from sources like auto loans, credit cards, and delinquent accounts.

Debt is not just something we possess; it’s a burden many of us have trouble repaying. An increasing number of people are having trouble paying their education loans. As of late 2013, more than one out of 10 borrowers (11.5 percent) were at least 90 days past due on student loans, and the 90-plus day delinquency rate on credit cards also increased from 2012 to 2013.

Considering debt is obviously a concern for the vast majority of consumers, most people have a general idea of what to do to get out of debt. Most of us know to organize the budget and repay the highest-interest debts first. On the same token, just as some decisions are productive and effective in regards to getting out of debt, some choices have the exact opposite effect. This list of foolish ways to handle debt uses information from a How Life Works article and supplemental information from other reports.

1. Borrowing from loved ones

If you are in debt, it’s not a good idea to borrow money from family and friends to help you “get back on your feet.” In reality, you’re not getting back on your feet — you are simply changing creditors. Instead of owing a business, you now owe someone with whom you have a personal relationship, a relationship you likely value.

Although these types of arrangements often end with some sort of negative result, the majority of people still choose to go this route at some point in their lives. According to a money etiquette survey published on Dave Ramsey’s website, around 70 percent of people lend to family members at one time or another, and 54 percent of people report lending money to friends. Of those lending $100 or more, 55 percent don’t receive repayment. Further, 57 percent of people have had a personal relationship ruined after one party borrowed money and did not repay.

Without the fear of foreclosure, high interest, or late penalties in most cases, you may pay other obligations first, and repayment to a loved one gets put on the back burner. To avoid any potential damage to a personal relationship, it’s better to avoid bringing money exchanges into the picture if at all possible.

2. Consolidating debt

When you’re faced with a large amount of debt, you may be tempted to consolidate. You see the commercials and advertisements, and it sounds like a good idea. These consolidation programs generally involve a new loan, often a loan for a large lump sum of money. This large sum pays off your smaller balances to creditors, and then you make monthly payments on this one loan.

The problem with this method is the additional money you pay in fees and interest, which may result in higher debt than you originally started with. Additionally, many of these consolidation programs deal in secured loans. This means that to obtain the lump sum loan, you are taking a second mortgage on your home, and if you do not repay, you could lose your house.

Debt consolidation is not a preferred method of managing debt. It can help some people in some situations, but it is not ideal unless you have already exhausted preferred methods, such as working with your creditors.

3. Paying just the minimum

Investopedia compares paying the minimum payment to running on a financial treadmill: It’s highly unlikely you’ll ever get to where you want to go. Say you have a credit card with a $10,000 balance, an 18 percent interest rate, and your minimum payment is around $250. If you purchase new furniture for $10,000, it would take you around 28.5 years to pay for it in full, and you will pay more than $14,000 in interest.

Imagine looking at that 1o-year-old furniture in 2024 — one of its legs wobbles and its condition is subpar. Considering you’d still be making payments on the set for years to come, do you think you’d be satisfied with a purchase for furniture with value that has depreciated down to almost nothing?

4. Bankruptcy

Roughly 332,000 consumers had a bankruptcy listed on their credit report during the fourth quarter of 2013. Bankruptcy is an absolute last resort, and it does not wipe the slate clean. Certain debts, like student loans and child support obligations, will not go away after a bankruptcy, and you still have to pay for current items, like your mortgage payment.

What bankruptcy will most likely do is provide some relief for your credit cards and unsecured debts. This comes at a high cost, though. Not only is bankruptcy expensive, it also spotlights your personal finances and stays on your credit report for many years. Bankruptcy can also involve the sale of your property, or you may have to follow a strict repayment plan.

When a household has a high amount of debt, there is one common cause. That is, spending is too high relative to earnings. The only real manner in which to permanently manage debt is to change the behaviors and thought processes. When a little bit of extra money enters the picture, we have to think about savings and the future, as opposed to what we can buy today. Otherwise, the cycle will continue, and any efforts to repay creditors will likely be temporary fixes followed by periods of increased spending.

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