What is the best way to pay down $30,000 in credit-card debt?
We probably don't need to tell you that carrying $30,000 in credit-card debt is a serious problem. (Not to rub salt in the wound, but do you know how much you're paying in interest each month?) You're right: It's time to consider drastic measures to dump this debt.
Figuring out the best way to pay off credit-card debt depends, in part, on how you accumulated it. Was it the result of a one-time incident (like an illness or job loss), or is it the result of a chronic spending problem? "If it's a lifestyle issue, you need to be looking at budgeting," says Ellen Fairbanks, a certified financial planner (CFP) with MDNA Financial in Pittsburg. "When people have a lifestyle they can't support, even if they get $30,000 paid off, it won't be five years before they have another $30,000 in debt, or more." Our cash-flow worksheet can help you create a budget that works for you. Alternatively, a reputable credit counselor can help you set up a budget and negotiate a repayment plan with your creditors.
Exercising stock options (and then selling the stock) or taking out a 401(k) loan are worth considering only if your debt was incurred because of a specific incident. And even then, you must weigh the pros and cons before you act.
With stock options, we're assuming that your employer allows you to do a "cashless exercise," during which a brokerage house -; usually one associated with your company -; lends you the money to buy the stock, sells it at market price and cuts you a check for the after-tax profit. If that's the case, keep in mind that your profit will be taxed as ordinary income, says Elaine Bedel, a CFP with Bedel Financial Consulting in Indianapolis. That could eat up as much as 35% of your profit, so your net profit could be quite thinner than what you hoped for. (And if your employer doesn't allow cashless exercises, you'd have to come up with the cash to buy your stock options before you sell them.) In addition, selling the stock means you'll miss out on future growth. So ask yourself: Do you expect the stock to rise significantly over the next five years? "If you sell now and next year's return adds up to 30%, you're going to shoot yourself for selling earlier," Bedel says.
Borrowing from your 401(k) plan might seem attractive. Chances are, the interest rate would be lower than what you're paying to your credit-card companies, and, better yet, you'd be paying that interest to yourself. But 401(k) loans have to be repaid within five years. Should you lose your job at any time, the loan could be called in immediately. If you don't have the money, you'll be charged income taxes and a 10% penalty on the amount due.
Another reason not to tap your 401(k): These plans are protected from creditors should you be forced to file for bankruptcy, says Fairbanks. Her advice is to explore all other possible options before you even look at your 401(k). For more on this, click here.
Another common strategy for paying off credit-card debt (although you don't mention it) is a home-equity loan. With interest rates so low, it's easy to see why. (The current interest rate for a $30,000 loan is just 6.3%, according to Bankrate.com, and that's before the tax break.) But be warned: 72% of consumers who consolidate debt with home-equity loans or refinancing end up in credit-card debt again within two years, according to Gerri Detweiler, author of "The Ultimate Credit Handbook" and founder of DebtConsolidationRX.com, a Web resource on debt counseling and consolidation. "There's a real risk that you could end up with low equity in your home and more debt problems," she says.
The other solution, of course, is to skip the fancy maneuverings and slowly work to pay down your cards. If your credit is scattered among many different cards, then yes, consolidating the debt onto one low-rate card could make this process easier. But be warned: As tempting as those 0% APR offers may seem, that interest rate will bounce up once the introductory period flies by, which could leave you back where you started. Look instead for a credit card that has a low rate even after the introductory period is over.
You might also call your creditors and try to negotiate lower interest rates, says Detweiler. More than half of all consumers who try this are successful, according to a 2002 study of the Massachusetts Public Interest Research Group. Of course, you'll have better bargaining power if your credit is in good shape and your account is in good standing.
No matter what, once you consolidate your debt and negotiate lower interest rates, make sure to apply the extra savings toward card payments. For more advice on digging out of debt, visit our Debt Management Center.