After you have taken stock of your debt and looked at how long it will take to repay it, you might be discouraged at the time and effort needed to reduce your obligations by paying just your minimums and a bit more. It is tempting to look at assets you might be able to convert to cash. If you're contemplating filing a bankruptcy case though, you may be wasting those assets by using them to pay debt now.


Or, perhaps you're thinking about borrowing more to service the debt you already have.

Here are some of those resources and why it might be a bad idea to go that route.

Retirement savings

Cashing in an IRA or a 401(k) account might seem like the logical step toward financial wellness. After all, the money is just sitting there, and you won’t be using it until you retire. You may wonder, why not use it now to pay down some or all of your debt? Not a wise move, most experts agree. If you withdraw the money before you’re age-eligible, you’ll incur hefty tax penalties up to 20%. You may be allowed to take out a short-term loan of cash from the 401(k), but you will be required to pay it back or else suffer the same penalty.

Using the money from a retirement account to pay down debt in order to avoid bankruptcy might work, but it could put you back to square one in preparing for retirement. Keep in mind that if you use your retirement savings to pay down your debt, and then decide to file bankruptcy anyway, you’ve lost a valuable asset for nothing.

That’s because you can protect ERISA-qualified IRAs, 401(k) accounts and other types of retirement savings when you file bankruptcy. Those funds are exempt from attachment by creditors or bankruptcy trustees.

So, if you think there’s even the remote possibility that you’ll choose to file bankruptcy in the future, do not use retirement savings to retire consumer debt that will be discharged in the bankruptcy anyway.

Home equity

The caution we express for retirement savings goes double for home equity.

The bankruptcy exemption for the equity you have in your home is different than the exemption for retirement savings. ERISA-qualified retirement plans are exempt under federal law regardless of your home state, but exemption of home equity value is governed by state law. Some states dictate that you follow a state-specific exemption list. Others use the scheme contained in the Bankruptcy Code. Some states allow you to choose between the two. Learn more about exemptions at our article Bankruptcy Exemptions: Schedule C.

How much home equity you can exempt depends on the amount of equity you have and the exemptions available to you.  Consequently, in some states you can exempt the entire value, but in some states you can only exempt a few thousand dollars’ worth. In every state, however, at least some of the equity will likely be protected in a bankruptcy filing.

If you use that value now to pay off debt that could be discharged in a bankruptcy later, and you find after the bankruptcy that you cannot make the payments on the home equity loan, you could lose your house to foreclosure. If, however, you decline to use home equity and file a bankruptcy case, you could eliminate credit card debt and save home equity value at the same time.

Your options depend on many factors, and the only way to know what’s best for you is to visit with a qualified bankruptcy attorney. Most offer initial consultations for free or for a small amount.

Check out this article on finding a good attorney: Finding a Bankruptcy Lawyer.

Transferring Balances or Taking Out Other Loans

If you’re lucky enough to still be receiving balance transfer offers from mainline credit card companies, transferring a balance from a higher fee credit card to one with a lower interest rate is not a bad idea. Keep in mind, however, that most of those lower interest rates are introductory and will usually last no longer than six months or so before the company jacks them back up.

Using other types of credit to pay off old debt may put you into a bigger hole than you’re already in. It probably goes without saying that your credit score will decrease and credit will become more expensive as your balances grow and your history shows late and missed payments.

You may be tempted to turn to payday loans or car title loans. This is a huge mistake. Except for the most short term emergency lending when you are practically guaranteed to be able to pay off the debt virtually immediately, I would never recommend payday or title loans. They are extremely expensive, sometimes upwards of 600% interest, and their repayment terms are extraordinarily difficult. Some will not allow you to make partial payments to reduce the debt. Instead, you have to pay interest and roll the entire principal amount over for another week or month until you can pay the principal in full. It’s a trap that few people can actually overcome. You’re much better off dealing with your original creditors. 

Consolidation loans are also tricky. You could take out a loan to pay off your other debt, perhaps at a lower interest rate, but most people find it very difficult to resist the temptation to continue using those credit cards. Before they realize it, they've built up credit card balances in addition to the consolidation loan stretching their resources even further. 

Next in the series: Tackling Your Debt:  Dealing with Debt Collectors