4 Counter-Intuitive Ideas to Help You Get Out of Debt

by Kevin on October 1, 2009

This guest post is by DR from the Dough Roller, a personal finance blog.

I’ve been intensely focused on repaying debt as of late. And in the process, I’ve come upon some unconventional methods to help me reach my goal of being debt free faster. Listed below are four them that may prove helpful to you as you battle your own debt and move towards greater wealth.

Embrace CD Penalties

Certificates of Deposit, unlike demand deposit accounts, typically levy a penalty if you withdraw the money before the CD’s term expires. For example, if you fund a 12-month CD, but end up needing the money in month eight, most CDs will charge a penalty equal to several month’s interest. (Note: There are some no-penalty CDs to consider, including a 9-month no-penalty CD from Ally Bank). Many view the potential penalty for early withdrawal as a negative feature of CDs, and in many cases it is. But if you are struggling to get out of debt, the CD penalty may be your best friend. Here’s why.

First, even if you are paying off a lot of debt, it is absolutely critical to save up and maintain an emergency fund. Even Dave Ramsey, who is about as conservative a financial pundit as you’ll ever find, recommends a $1,000 emergency fund as your first step. The reason is that an emergency fund will enable you to handle unexpected expenses without going into more debt, and it instills good financial discipline that building wealth requires.

And that brings us to the second point. Early on in your financial journey out of debt, you may find discipline to be a rather rare commodity. I know I have from time to time. And that’s where a CD, with penalties for early withdrawal, can help. The penalty will discourage you from accessing the cash unless it is a true emergency. There have been times where I’ve needed the extra incentive to keep from spending money I’m trying to save. While there is a risk you may need the money early, that risk is often offset by the higher interest rates you can get from CDs. If you are looking for a great CD rate, Kevin has put together a helpful page on how to use Money Aisle to find great rates.

Focus on Non-Revolving Debt First

A lot has been written about which debt one should tackle first. The “obvious” answer is to pay first the debt with the highest interest rate. While that’s certainly a reasonable approach, it’s not the only approach. Dave Ramsey believes you should tackle your smallest debt first. The idea is to get your smallest debt paid off as soon as possible to give yourself a feeling of progress. It can also free up cash flow. But as a third approach, consider tackling your non-revolving debt first.

Recall that non-revolving debt, like a car loan or school loan, once paid off is gone for good. You can’t charge the debt back up. With revolving debt, like a credit card, you can charge the account back up once you’ve paid some or all of it off. For this reason, you may want to make extra payments on the non-revolving debt since there’s no risk that you’ll run the debt back up. Of course, the interest you are charged on your debts should be a key factor when making this decision, but consider the type of debt too as you develop a debt repayment plan.

Work Hard to Improve Your Credit Score So You Can Go Into More Debt

Even if you vow never to go into more debt, your credit score is a critical component of any ‘get out of debt’ plan. A solid credit score qualifies you for low rate mortgages, home equity lines of credit, car loans, and the best credit card deals. Each of these credit products can be used to lower your interest rates on your current debt. If you can refinance your mortgage, for example, you may be able to lower your monthly payments by hundreds of dollars and save thousands in interest payments. Likewise, with a low interest home equity line of credit, you may be able to consolidate high interest rate credit cards, saving a lot on interest payments and possibly taking advantage of tax breaks.

But the key to low interest rate loans is excellent credit. You should be aiming for a credit score of at least 720, and today you really need about 740-750 to be considered an excellent credit risk. If you’ve never checked your credit score, or haven’t done so in quite a while, it’s easy to get your score for free from MyFICO.com. And MyFICO also provides information on how to improve your score. Kevin has already written a detailed post on how to get your free credit score, which you can check out.

Keep (And Use) Your Credit Cards

First, if you have credit cards, think twice before canceling them. One of the big factors affecting your credit score is your ratio of debt to available credit. The more unused credit you have, the better your credit score, all other things being equal. By canceling credit cards, you reduce your ratio of debt to available credit, which could adversely affect your credit score.

Second, if you can do so without going into more debt, take advantage of credit card rewards that can lower your interest rate and provide cash back. As Kevin has noted in the past, cash back credit cards used for everyday expenses give you free cash you can put toward your debt. One tip if you are concerned about overspending is to pay off your credit card repeatedly throughout the month. We use the Discover More card because it pays up to 5% cash back, and I pay off the card about 5 times a month.

You can also take advantage of 0% balance transfer credit cards. While you do have to watch out for excessive balance transfer fees, there are 12-month offers available that can be a money saving alternative to double-digit interest rate credit cards.

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Steve in Denmark October 2, 2009 at 12:45 am

I’m curious about the ‘Emergency Fund’, our man recommends here.
My wife and I pay into something called an ‘A-kasse’. There are many of them here in Denmark and it seems that most people pay into them. They are basically glorified unemployment insurance funds. If you get made redundant, they pay your wages for a certain period, I think it’s often a year or so. The more you contribute each month, the more you’d get each month, should you be made redundant. We’re with Kristelig Fagbevægelse and they also will help with most aspects of finding a new job. We pay 600kr each a month (I think you would currently times that by 5 or so, to get it in Dollars).
What I’m thinking is, that this must be the equivalent of the Emergency Fund most of the (US) finance bloggers talk about. Am I right, or should I also start one? They would seem to be one and the same, the only difference being that we won’t get the money we’ve paid in back, if we (hopefully) never need the service.

Kevin October 2, 2009 at 7:33 am

Steve, an emergency fund is private (as in, you own it) savings for future unknown expenses.

Most financial gurus recommend 3-6 months or 6-12 months worth of your living expenses saved up for emergencies. So if your living costs (mortgage, food, utilities, etc.) are $2,000 per month and you wanted to have a 6-month emergency fund… you would save $12,000 on your own in a savings account.

That way if you lose your job, the roof needs replacing, etc. you have money set aside for it.

Are you saying you put $3,000 USD in this A-kasse thing? Holy cow — that is a ton of money they you potentially will never see again!

Steve in Denmark October 2, 2009 at 8:03 am

I better check the Exchange Rate here…Erm…it’s not as astronomical as you/we think. 1200Dkr (2 x 600Dkr), comes to roughly $235. We pay that a month (between us). Phew!

But, as I say, it will do everything the Emergency Fund would do (ie replace your wages, etc, and therefore pay all your expenses just as if you were still working), and for at least 12 months. Plus, they give you all sorts of help with finding a new job – sorting your CV out, calls, ideas, etc – down to getting you onto courses where you can increase your employability or even re-train for something else, should you wish. If you go onto a course, or take a ‘new education’ (as it translates to here), you’ll get paid as well.

The only down-side, is that the money isn’t yours’ at the end of the day. It’s an insurance policy. You don’t save it up and so, if you don’t need it, you don’t get it back. But, I think that the benefits over and above having everything paid for each month, just as if you still were in work and earning, outweigh that particular down-side.

I’m just working on a new layout for our budget (make it easier to identify cost saving areas and so include budgets and automation, like old Ramit says) and was trying to figure out if we needed to allow for an Emergency Fund. While most of me says ‘no’, there is a little voice at the far end of the room there that is saying ‘try and work something in’. We could save up the equivalent of a years’ A-kasse payments, put it in a high-interest account, then drop the A-kasse payments I suppose. But that’s gonna take a bit of doing, won’t come to fruition any time soon and will have to be done alongside our regular A-kasse payments.

It’s a nutty one…

Mesa AZ CPA December 1, 2009 at 4:10 pm

This post just shows that you have to work hard to really reduce debt and improve your credit score. People too often are just looking for a quick fix or a miracle. With some work and a little diligence you can improve your credit situation.

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