Trying to pay off credit cards and get out of debt can lead to straight into a debt trap. Here's a list of five 'debt traps', and how to avoid them.
Credit cards
They are double-edged sword. While they can be helpful when you're short on cash, they can become a burden if you don't manage your accounts wisely. The fees can be exorbitant: $39 or more if you pay late, $35 or more if you go over your limit. And if you use a credit card for cash advances, the interest can be much higher than your purchase rate. Plus, most creditors charge from two to four percent of the amount advanced. What to do: Read all credit card agreements closely, and make all payments on time, every month. Better yet, don't use credit cards at all!
Overdraft protection/Bounce protection
This covers payments above your balance. But it's not free. The overdraft fee for a bounced check or over-limit withdrawal can be $35, and some banks also charge a 'daily fee'; of $10 or more until you repay the overdraft amount. What to do: Make sure you're aware of all the terms and fees before accepting overdraft protection.
Mortgage refinancing
When rates are low, it's tempting to refinance your home. After all, your monthly payments will go down, and you'll get some extra cash to pay off your credit card debt, right? Not necessarily. Only people with very high credit scores qualify for the lowest rates. And even if you qualify for a low rate, there are costs and other considerations, such as: Do you really want to sign up for another 30 years of mortgage payments? What to do: Before you jump on the re-fi bandwagon, find out what kind of rate you might qualify for, and what costs are involved. It could be a costly mistake.
Payday loans
These loans are basically very expensive credit. You write a personal check to a lender that includes a fee. The lender holds the check until your next payday, at which point they deposit your check or you chose to pay another fee to extend the loan another two weeks. Let's say you borrow $100, which initially costs you $120. Say you roll the loan over three times (3 x $120). You have now paid $60 to borrow $100 - that's an annual percentage rate of 521 percent! What to do: Don't use them, unless absolutely necessary, and never roll them over.
Car title loans
These loans are secured by the title of your car. The lender decides how much it will loan you for the car and the time period of the loan. Not only can the annual interest on these loans be as high as 264 percent, but you may also lose your car if you're even one day late on a payment! What to do: A payday loan should be used only as a last resort. If you do take one out, always make your payments on time. Pay it off early to avoid the high interest rates.