If you have substantial credit card debt, you may feel trapped.

By Ben Woolsey
Published: March 25, 2006

If you have substantial credit card debt, you may feel trapped. Escaping debt is a must, but there are both right and wrong ways to go about it. Unfortunately, those dressed up as a quick fix tend to cause more problems than they solve. Below are four common but ill-advised "solutions" for credit card debt:

1. Get a home equity loan and pay off everything

Ah, if it were only that simple. A home equity loan can be relatively fast compared to a full-blown mortgage loan, but there is a price to pay. Many costs, especially origination fees, often aren't disclosed until well into the application process. And remember, you’re putting your home on the line. Harrine Freeman, author, speaker, columnist and CEO of Freeman Enterprises, a credit repair and financial counseling service, says that taking out a home equity loan should be a last resort. “Don't get one if you already have bad credit, if you can't afford to make your current mortgage payment or if you are not sure that you can make the home equity loan payments,” Freeman says. “If you make a late payment, your interest rate may increase. This is only a temporary solution because you could easily get into debt again.” She insists that home equity loans should only be used for covering costs of large purchases such as roof repairs or an unexpected emergency.

2. Rob your 401(k) or other retirement savings

This is a bad idea since any time you touch tax-advantaged retirement savings you get dinged twice. You will first experience the pain of paying a 10 percent penalty for early withdrawal, and you will then be taxed at your normal income tax rate for the amount withdrawn. For most consumers this means keeping only 65 percent of the money withdrawn. Freeman admits borrowing from your 401(k) can have a few advantages, including a good interest rate and the fact that you are paying interest back to yourself instead of a lender. The downsides, however, are devastating. “If you are unable to pay the loan at the time, you will also be required to pay taxes and penalties on the amount borrowed, and the loan must be repaid in five years,” Freeman says. “If you lose or quit your job you will have to pay the loan back in full. When your borrow money from your 401(k), you are taking money that can generate additional growth in your retirement plan and affects your overall projected earnings.”

3. Take a cash advance on another card

The expression "robbing Peter to pay Paul" comes to mind with this one. For starters, taking a cash advance on a credit card is a very expensive proposition. There is usually an ugly 3 percent fee charged for advances along with very high interest rates that begin ticking away from the moment you initiate the advance. “Cash advances are very costly, high-risk items,” Freeman says. “The cost of a cash advance from a credit card can be 500 percent or more.” Don't dig one hole to fill in another.

4. Get a payday advance against your next paycheck

Payday lenders offer a solution for short-term emergencies. They're not meant as a long-term fix for credit card debt. When calculated on an annual basis, their interest rates are astronomical. Freeman concedes that payday loans have advantages: the possibility of getting your loan extended, no credit check and avoiding bounced checks or late fees on credit cards. But that’s where the good ends. “You have to pay back the loan plus fees, and extending your loan can double or triple your fees,” Freeman says. “The interest rate can be as much as 100 percent or more of the amount borrowed and you could end up owing more debt after obtaining the payday loan.”

Right ways to escape credit card debt

If there are so many dangerous routes to becoming free of credit card debt (and indebted elsewhere), what represents the golden path? The answer doesn't involve a quick fix, but will provide a safer, long-lasting solution. The first step requires a change of behavior. “The main obstacle is changing your spending habits,” Freeman says. “By simply doing that, you will be able to reduce expenses and pay off your debt.”

Her advice:

• Don’t open any new accounts.

• Reduce expenses by bringing your lunch to work, taking public transportation, shopping at wholesale stores, etc.

• Don't transfer balances unless you can pay the full balance before the promotional period expires.

• Budget, budget, budget. “Create a spending plan to determine the total amount you owe and your total monthly income to see where you can reduce expenses,” Freeman suggests.

She also says to focus on paying your bills on time and alerting your creditors immediately if you will not be able to pay your bills when they are due. If need be, cut up all of your credit cards except for one to use for emergencies -- and keep that one safely tucked away to reduce splurge temptation. Once this financial bleeding has been stanched it's time to go to work on whittling down that debt. Finding a good 0 percent APR balance transfer credit card is often a good next step. Think of this credit card as a debt consolidation loan; don't carry it in your wallet. It's simply a place to park your debt at no interest in order to begin cutting it down. Attaining freedom from debt at this point is a matter of using your newly budgeted income to pay it off bit by bit until it is gone. It takes time and self-discipline to destroy debt, but once you are free of its shackles, you will lift an enormous weight off your back.