5 Tips for Paying Off Debt During COVID-19
The COVID-19 pandemic has affected millions of Americans, including everyday consumers and small business owners alike. The various economic impacts, such as rising unemployment, may have you rethinking how you manage your finances. Paying off debt during COVID-19, if you can, is one way to get ahead and possibly help improve your financial health.
Collectively, Americans owed $14.3 trillion in household debt as of the first quarter of 2020, including mortgage loans, auto loans, credit cards, and student loans. How that debt might look at the end of the second quarter is anyone’s guess. If, however, you’re ready to start making a dent in what you owe, these tips may help you accelerate your COVID-19 debt payoff.
1. Managing Credit Cards With a Balance Transfer
Despite the Federal Reserve cutting interest rates to help stem some of the financial fallout from the coronavirus crisis, there hasn’t been much of a trickle down effect where credit card annual percentage rates (APRs) are concerned. So if you’re carrying high-interest credit card debt, lowering your APR may be key to paying it off more quickly during COVID-19.
One option may be to reach out to your credit card company and ask for an interest rate reduction. Some credit card issuers are offering coronavirus credit card relief for people experiencing financial hardships.
If you don’t qualify for that type of help, a balance transfer to a card with a 0% promotional APR may be a solution. Transferring a balance to a card with a lower (or no) interest rate allows more of your monthly payments to go toward the principal. That may help you get out of debt faster and save money on interest charges.
Just remember to factor in the balance transfer fee, since that can add to your payoff balance initially. For example, a 5% balance transfer fee could add at least another $500 to your debt if you’re transferring a $10,000 balance. Additionally, balance transfers can negatively affect your credit score, since a hard credit inquiry is required to apply for a new card. And running up a balance on the cards you just zeroed out can create more debt problems.
2. Considering Tapping into Your Retirement
Ordinarily, withdrawing money from your 401(k) or an individual retirement account before you reach retirement age would trigger a tax penalty. The federal CARES Act , however, makes accessing those funds easier by including these provisions, which allow you to:
• Borrow up to $100,000 from your workplace plan using a 401(k) loan (the regular limit is $50,000)
• Repay 401(k) loans within five years with no income taxes owed
• Withdraw up to $100,000 from a 401(k) or an IRA with no 10% early withdrawal penalty
• Avoid paying income tax on IRA withdrawals if the money is repaid within three years
• Extend payment of taxes for amounts withdrawn that are not repaid over a three-year period
Being able to withdraw money from your retirement accounts penalty-free and potentially tax-free if those amounts are repaid in time is tempting if you want to pay off debt as quickly as possible. But you could end up owing a significant amount in taxes if a 401(k) loan or IRA withdrawal isn’t repaid within the timeframe set by the CARES Act.
Not to mention, paying off debt during COVID-19 this way means potentially short-changing your retirement future. Money that’s withdrawn from your accounts has less opportunity to grow through the power of compounding interest, so you may end up with a smaller nest egg for your later years.
(Note: You should always consult with a tax professional after reading educational blog posts before you make any and all tax-related decisions.)
3. Borrowing Against Your Home Equity
If you own a home, you might consider using your equity to consolidate and pay off debt during COVID-19. While the Fed’s rate cuts don’t directly affect mortgage rates, mortgage rates have continued to edge closer to near-historic lows as a result of changing economic conditions brought on by the pandemic.
A home equity loan could be a way to consolidate high-interest debt, such as credit cards, if your credit history and income (among other factors) allow you to qualify for the lowest rates. That could potentially save you money when paying off debt during COVID-19.
The biggest downside of using home equity loans to pay off other debts, however, is what can happen if you’re unable to repay the loan. Home equity loans use your home as collateral, meaning that if you default on the loan, the bank could initiate a foreclosure proceeding against you.
For that reason, a home equity loan may only be something to consider if you’re secure in your job and confident that you’ll be able to make the payments, along with your regular mortgage payment.
4. Considering a Payday Loan, with Caution
Payday loans are short-term loans that allow you to borrow against your future paychecks.
On the pro side, payday loans may be easier to qualify for than other loans, and funding is typically fast. It’s possible to get money in hand the same day you’re approved for a payday loan that you could use to pay off debt or cover other personal expenses.
But the cons for payday loans can easily outweigh the pros. The biggest is cost. Payday loans can have effective interest rates reaching into the triple-digit range , making them far more expensive than a balance transfer, 401(k) loan, or home equity loan.
Not to mention, payday loans can easily create a cycle of debt that can be difficult to climb out of. If your paycheck is smaller than expected and you can’t cover your existing payday loan, you may have no other option but to roll that amount into a new payday loan. And if your paychecks continue to remain low because COVID-19 has affected your working hours, you could quickly get buried under a mountain of high-interest debt.
5. Paying Off Debt with a Personal Loan
Last but not least, you may consider using a personal loan to consolidate and pay down debt during COVID-19. Here are some of the potential benefits of using a personal loan to pay down debt:
• Loans can be used to combine and/or pay off a variety of personal debts.
• Interest rates for personal loans are typically lower than credit cards or payday loans.
• Unsecured personal loans allow consumers to borrow money without offering collateral.
• Online lenders typically make applying for personal loans quick and easy.
The main con with taking out a personal loan, or using any of the other measures included here, is that you’re creating new debt to pay off old debt. This can have an impact on your credit score and your ability to qualify for future loans. But if you’re able to reduce the cost of that debt by getting a lower interest rate or minimizing fees, an unsecured personal loan could be part of a good solution for working toward debt freedom during the coronavirus pandemic.
Doing Your Homework on Debt Payoff Options
There’s more than one way to manage debt during COVID-19 and it pays to take your time when making a decision. If you’re interested in a personal loan, for instance, you’d likely want to first compare loan terms, interest rates, and fees before choosing a lender. Doing so can help you find the loan that best fits your needs and budget for paying off debt.
That’s something SoFi personal loans can help with. You can quickly and easily check your rates without affecting your credit score.1 From there, you can move ahead with applying for a personal loan, if you so choose, and get started on the path to erasing high-interest debt for good.
1Checking Your Rates: To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score. A hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being pre-qualified.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.