NEW YORK (MainStreet) — Digging yourself out of credit card debt can be a huge financial challenge. As the bills begin to mount on one or multiple pieces of plastic, it's easy to feel overwhelmed and unsure of how to pay it all off. Unfortunately, far too often people fall into some common pitfalls when attempting to tackle their debt and wind up doing more harm than good. To help you avoid these mistakes, we consulted money management experts for their tips on the smartest and dumbest ways to pay off credit card debt. Here's what they had to say.
DUMB: Borrowing Against Your Home
If you're considering using your home as collateral to get a home equity loan or line of credit to help pay your credit card bills, think again.
"When you borrow against your house to pay off credit card debt, you are putting your primary asset and equity at risk, because you might end up defaulting on your monthly mortgage payments," says Robert Rasmussen, chief operating officer for Balboa Capital. "This puts your home in danger of foreclosure."
Howard Dvorkin, chairman of Debt.com and the author of Credit Hell: How to Dig Out of Debt (Wiley, 2005) and Power Up: Taking Charge of Your Financial Destiny (Wiley, 2013), says he's witnessed "horror stories" of houses being seized from people who decided to borrow against their home to pay off credit card bills.
"When people ask me about this, I tell them all the time—don't risk losing your home," Dvorkin says. "People panic, borrow against their home and then can't pay the loan back—and a bad situation turns into a catastrophic one."
DUMB: Taking Out a Payday Loan
A payday loan may seem like a good idea in theory—it's a short-term loan that's designed to get you through to your next paycheck. But the truth is that if you're planning to use a payday loan to pay off your credit card debt, you'll likely soon find yourself in even more hot water.
"You can't stay financially afloat using payday loans—their interest rate is outrageous, as much as 300% to 600% or more," says Dvorkin. "When you can't pay them back on time, the payday loan lender rolls over the loan and charges you fees. Soon the fees you're paying are more than the loan itself and you're caught in a viscous cycle, or what's been referred to as a 'payday loan treadmill.'"
DUMB: Cashing Out Your 401(k)
Dipping into your 401(k) retirement plan to pay off your credit card bills may be tempting, but financial experts say it's actually quite foolish.
"Withdrawing from your 401(k) ultimately hurts your future," says Dvorkin. "If you don't have enough money to retire, you'll be working while others are playing golf and enjoying their golden years."
You can also face harsh penalties if you withdraw money from your 401(k) before you reach retirement age.
"There is a 10% federal tax on the amount taken from a 401(k) before age 59½," says Rasmussen.
DUMB: Only Paying the Minimum
Sure, you technically could pay only the minimum on your credit card bill each month, but doing so won't help you rid yourself of all that debt.
"It can take forever to get out of debt if you only pay minimums," says Beverly Harzog, consumer credit expert and author of Confessions of a Credit Junkie: Everything You Need to Know to Avoid the Mistakes I Made (Career Press, 2013). "Not to mention, the longer you take to pay it off, the more you pay in interest expense."
Harzog recommends going through your budget and cutting expenses where you can, then taking the money you're saving and applying it to your credit card payment that month.
SMART: Pay Off Higher-Interest Cards First
If you have credit card debt on multiple cards, consider paying off the cards with the highest interest rates first, because they are probably costing you the most each month, says Michelle Brennan Hall, president of Brennan Wealth Advisors in Addison, Texas.
Of course, if your credit cards charge similar interest rates, tackle the card with the highest balance before moving on to the others.
"When you pay off your credit cards that have the highest balances first, you are reducing the total amount of interest charges each month," says Rasmussen. "Generally speaking, a large credit card balance translates to large interest charges, and this reduces the amount of money you will have available for other expenditures each month."
SMART: Consolidate your high-interest credit card balances to one low-interest card
If you have several credit cards with high interest rates, you might want to consider consolidating your debt onto one credit card that has a lower interest rate.
"Doing so will make it easier to pay down your credit card balance faster because the monthly payment is more affordable," says Rasmussen. "Having one credit card payment is also more manageable because you won't have to make payments to several credit card providers."
Of course, if you decide to use this strategy, Rasmussen says it's a good idea to put a cap on your spending so you don't accumulate new debt.
SMART: Find Ways to Cut Costs
Your spending got you into this mess in the first place, so it's time to cut back. Before choosing a cost-cutting strategy, though, it's a good idea first to evaluate your monthly expenses.
"Add up all of your fixed bills—mortgage, rent, car payment, cable television, mobile phone, utilities—to get a clear picture of your finances," says Rasmussen. "Once you determine how much you owe on a monthly basis, you can think of ways to reduce your discretionary spending and focus on paying off your credit cards."
For instance, maybe it's time to cut back on those daily Starbucks lattes, cancel your extra movie channels and cook more at home instead of eating out.
SMART: Allow small splurges
There's no denying that paying off your credit card debt takes discipline and self-restraint, but you don't exactly have to live like a monk, either.
"Smart consumers celebrate little victories along the way, not by going out and having a steak and lobster dinner in a fancy restaurant, but by treating themselves to inexpensive activities like a manicure or meeting a friend for a drink," says Harzog.
Harzog likens getting out of debt to dieting. While cutting back on purchases and unneeded expenses is a must, if you deprive yourself too much, you might actually want to spend more.
"Be realistic and make sure you get to enjoy life a little bit while you're paying off your debt," she says.
--Written by Kristin Colella for MainStreet