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Destroying debt? Avoid these mistakes

You've taken the steps to organize and pay down your debt. Now don't blow it.

By MSN Money Partner Feb 2, 2012 1:39PM

This post comes from Rob Berger at partner blog The Dough Roller.

 

The Dough Roller on MSN MoneyEditor's note: This post is part of a five-part series on The Dough Roller about destroying credit card debt.

 

So you have considered the decisions and circumstances that got you into your current debt situation. You are committed to doing something about it. You've taken steps to lower your credit card interest rates. You've set up the debt snowball system to pay off your cards as quickly as possible. And you've squeezed every dollar possible out of your budget to throw at your debt.

 

Now, in the words of my first boss as I was about to argue my very first motion in federal court, "Don't blow it."

 

You are primed for success, as long as you stay on track. Unfortunately, there are some common mistakes people make as they work their way out of debt.

 

Being too aggressive

What you do now is critical. If you approach debt repayment with unrealistic expectations and a timeline that is not achievable, you will be setting yourself up for failure. If your research indicates that with all the proper tools in place you should be out of debt in three years -- don't shoot for half the time.

 

Think of the last time you went on a crash diet with the expectation that you would lose some crazy amount of weight in a short amount of time. Meanwhile your friend went on a program that required a steady plan of action that modified behavior and focused on being fit and healthy when the goal was reached. I think we all know what happens next. Slow and steady wins the race.

 

Dave Ramsey tells his followers to attack debt with "gazelle intensity." That's fine, but just remember that even a gazelle has to rest from time to time.

 

Borrowing from your 401k

Taking out a loan from your 401k has some initial appeal. You get rid of high-interest credit card debt in exchange for a loan that typically charges much lower interest. And on top of that, the interest you pay goes back into your 401k, so you are really paying yourself the interest charges.

 

But there are three significant risks to this approach:

  • If you leave your job for any reason, you'll have to pay the loan back in full. If you fail to pay it back, the IRS treats the loan as a distribution, charges you a 10% penalty if you are not at retirement age, and taxes you on the rest.
  • The amount of the loan gets pulled out of your investments, which could have a significant effect on your retirement.
  • You run the risk of adding more debt to your credit cards, leaving yourself with credit card debt and a 401k loan.

I won't say that borrowing from your 401k is always the wrong choice, but it's rarely the right one. Post continues below.

Not saving the maximum for 401k matching

Readers often ask me if they should pay off debt or save their money. My answer is always the same -- yes. It's not an all-or-nothing situation. You can both pay off debt and save at the same time.

 

How much you put toward debt and how much you save depends in part on the interest rate of your debt. The higher the rate, the more you should put toward debt first. But there is one important exception -- 401k matching contributions.

 

If your employer matches some or all of your 401k contribution, you should contribute enough to get the full benefit of the match. Otherwise, you are turning down free money. Not taking advantage of this is like tossing cash out your car window.

 

Not tracking your progress

The opposite of being too aggressive and setting yourself up for failure is not tracking your progress at all. Tracking your progress is motivating. You can see how much you have paid down and pat yourself on the back.

 

If you are looking for a free tool to track your progress, I'd recommend Mint.com. It has great tools for tracking your accounts and monitoring your progress. If you don't mind spending a few bucks for a great budget tool, You Need A Budget is, in my opinion, the absolute best. It's what I now use for our monthly budget. You can read our full YNAB review for more details.

 

Giving up

There will be setbacks. Getting rid of credit card debt is one of the hardest things you'll ever do. As soon as you realize this, it all gets a bit easier. When you do make that purchase you later regret, think about what led you to that decision. Make any changes you need to, and then continue on your path to debt freedom.

 

But whatever you do, don't give up!

 

Balance is the key to life and debt. Consider what a full life means to you. Is it a life full of stuff or a life full of friends, family and stability. Understanding this will help you to determine if there is value in something you are considering as a purchase. Always ask yourself if you need it. Will it add value to your life?

 

More on The Dough Roller and MSN Money:

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