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Debt is a four-letter word to many people and learning how to debt free living is the ultimate goal. Debt is a major source of stress for an ever-increasing number of people. But unless you are independently wealthy, have a large savings account or emergency fund or have absolutely no debt – debt is usually a necessity if you want to make a major purchase such as a home or a car.
Consumer and household debt is on the rise, and so are delinquencies. More and more consumers are turning to credit counseling to get their debt under control. And even with the tighter restrictions on bankruptcy, people are still filing. These statistics paint a grim picture of debt, yet consumers are still using their credit cards and taking out loans.
The fact is that debt is not such a bad thing in and of itself. The problem lies in accumulating too much debt – more debt than you can manage and not being able to pay it off. If we are not careful, we can get in over our heads. And once we do, it becomes harder and harder to get out of debt.
If we educate ourselves about our finances and establish what is a “safe” debt level depending on our income and expenses, we can avoid starting the cycle of debt to begin with. And if we are already in too much debt, there are steps we can take to reduce it. Improving our finances is a great way to begin to get more organized and improve our life.
Good Debt vs. Bad Debt and Your Financial Goals
Yes, there is such a thing as good debt! There are only a few types of debt that fall into this category, but it is important to make the distinction.
Some examples of good debt are:
Debt incurred to buy a home
Owning your own home has numerous benefits. But the reason that this is considered a good debt is because a home is an investment. It gains value instead of losing it, so you are putting yourself at an advantage by going into debt if you keep your payments current.
Getting a college education is a worthwhile investment as well. By earning a degree, you put yourself in a position to earn more money over your lifetime.
Debt associated with starting a business
Starting your own business can be a risky proposition, but it is done with the intention of earning money. However, some of the assets you purchase will depreciate rather than appreciating. But for practical purposes, you can consider this a good debt.
And of course, on the other side, there are lots of examples of bad debt. Here are a few:
Having a car is a necessity for many, but a car loan is still considered bad debt. An automobile loses value over time rather than gaining it, so when it is time to sell or trade you will not recover your investment. (That is why I buy and not lease my cars and I buy them used as well!)
Credit card debt
Although credit cards can feasibly be used to purchase things that appreciate, they are in general considered bad debt because of the types of things that are usually bought with them. The overwhelming majority of credit card purchases are things that lose value.
Most personal loans
Personal loans are often taken out to finance purchases of things such as appliances, furniture, and vacations. Vacations can be Medicine too – they help us return home renewed and refreshed after having spent some quality family/social moments together in order better serve those around us while also earning more money because let’s face facts: who doesn’t want an improved debt free lifestyle?. But none of these things appreciate, so they are considered bad debt.
Just because a debt is a so-called good debt, that doesn’t mean it can’t get us into trouble. It is important to keep our good debt at a manageable level. Lending decisions are based on what a person can afford to pay back and how much of their total wealth they will use as collateral, among other things- but you’ll have more success getting an approval if your finances look good in comparison with comparable borrowers! But it is also crucial that we look at our individual situations and not borrow more than we can comfortably pay back.
On the other side of the coin, bad debt is not necessarily taboo. There is no harm in taking on some bad debt to get the things we need and want. But the smart thing to do is keep it to a minimum, only using it for things we really need.
How Much Debt Is Too Much?
There is no one-size fits all when it comes to managing debt. The best way for each person is different, depending on their income and bills as well as how much money they need every month in order not live paycheck by paycheck anymore! But in general, it is best to keep our total debts under 35% of our income.
Bad debt is the most important part of the equation. Ideally, we should keep it under 10% of our income. Anything higher is a sign that you may need to re-evaluate your finances.
Calculating your bad debt is easy to do. Simply add up your monthly credit card payments, auto loan payments, and any personal loan payments, then divide that number by your monthly income and multiply by 100 for your debt-to-income ratio. If you want to figure your total debt ratio, add in your student loan payments, mortgage, or rent, and any other monthly obligations you have, divide by monthly income, and multiply by 100.
How to Debt Free Living? An Ounce of Prevention Is Worth a Pound of Cure
The best thing we can do to avoid ending up in a vicious cycle of debt and get on the road to being debt free is borrow wisely in the first place. By remembering three simple things before we borrow, we can keep our debt manageable from the start.
1. Shop around for the best possible rates. When buying a car or a home, we almost always compare several options before settling on one. We should always do the same when obtaining credit. Whether it is a mortgage, car loans, or a credit card, getting the best rate you can get will end up saving you a lot of money overall.
2. Use credit wisely. If you can do without it, you are usually better off paying cash for it. Many people keep credit cards for emergencies, only to end up declaring a state of emergency when those expensive shoes they have been eyeing go on sale. This discretionary spending can and online shopping can lead to a dire financial stress. While one impulse purchase won’t hurt anything by itself, it can easily become a habit. And that spells trouble.
3. Pay your debt off as quickly as possible including student loans. If it is a mortgage or loan, add a little extra to the payment each month if you can, or better yet make an extra payment every now and then. For credit cards, pay off the balance in full each month. If that is not possible, pay as much as you can afford. Paying only the minimum payment each month will keep you out of trouble with the credit card company, but it will also allow interest charges to build up.
These steps sound easy, and they are. But it is also easy to slip up a time or two. When we do and it doesn’t cause any major problems, we often tend to become more lax on watching our credit habits. That leads to more mistakes, and those mistakes lead to more debt. If it continues, we can end up in too much debt.
Signs That You are in Too Much Debt
Figuring out your debt ratio can give you a good indication of where you stand. But sometimes you don’t need to crunch the numbers to know that you’re in trouble. And even if your debt ratios are at what is considered a safe level, your individual circumstances could still put you at risk. Here are some of the early warning signs that you may be getting in too deep:
- You’re only making the minimum payments on your credit cards each month. If you only make the minimum payment each month, it can take years to pay off even a small balance. And you’ll end up paying for your purchases many times over because of the compound interest.
- You use your credit cards for necessities on a regular basis. If you’re buying groceries or clothes with your credit card and not paying the balance in full every month, you could be headed for disaster.
- You charge more than you’re paying each month. Maybe you’re paying more than your minimum payment each month, but then you charge more than what you paid the next month. Even though you’re paying a little extra each month, things are still going in the wrong direction.
- You aren’t putting anything into savings. Having all your money tied up in debt doesn’t leave anything in case of an emergency. You might think you can live off your credit cards in a pinch, but that will lead to nothing but a financial disaster.
The above signs are cause for concern, but they signify the early stages of a problem. If you act quickly, you still have a chance of turning things around before it is too late. The following scenarios signify a need for immediate, drastic action:
- You’re not sure just how much you owe. If you have accumulated so much debt that you cannot even estimate how much you owe, that is a bad sign. Add it up, and you will likely find that it is much more than you thought. I know it is painful, but you can do it.
- You borrow from one source to pay another. Getting cash advances from one credit card to pay the payment on another does not get you ahead. It simply transfers your debt from one place to another. You usually end up paying extra fees or higher interest for the cash advance as well.
- You are approaching your credit limit. Ideally, we should keep our credit card balances at a fraction of our credit limits. Getting too close to your limit, or going over, is usually a sign that things are out of hand.
- You get turned down for credit. If you’re in over your head already, the last thing you need to do is apply for more credit. But if you do and are turned down, that’s usually a good indication that you’re in too much debt.
- You’re making your payments late or missing them altogether. If things have gotten to this point, you’ve probably already figured out that you are in too much debt. It is time to start looking at your options for getting out.
How to Get Your Debt Under Control – Save Money (and Become Debt Free Baby!)
To get debt under control, it is essential to have a plan. If we catch the problem early, we can often get things under control without any outside help. It takes lots of discipline, but with some planning it’s not difficult. Here is how to do it.
Stop incurring new debt.
Put the credit cards away! Have your spouse or someone else you trust hide them if necessary. And don’t get new cards or take out new loans.
Find ways to cut back on your spending.
Just brainstorm at first. Do you eat a lot of fast food instead of taking your lunch to work? Do you buy a latte every day? Do you make unnecessary trips? Write these things down to work with in the next step.
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Make a monthly budget.
Be sure to include all the necessities, as well as entertainment expenses and the like. But leave out anything that you can live without from the list you made. And save the loan and credit card payments for last because you will need to put as much toward them as possible.
Figure out how much you will have left over.
This should be split between credit card and loan payments and savings. See the next section for how to determine how much should go to which creditor.
Stick to that strict budget!
The only exceptions are in the case of a true emergency or when you can find unexpected ways to cut back. When you do find ways to cut back, put the money you save toward paying down your debt.
Prioritizing Your Debts
This is so important! A frequent obstacle for those who are trying to get their finances in order is figuring out what to pay off first. We know that we need to make the minimum monthly payment on each bill, but what do we do with the rest of the money we have budgeted toward paying down our debt? We prioritize and pay the most important off first, then go down the list until it is all paid.
Start by going through your monthly debt payments. The most important debt to pay off, or at least keep current, is secured debt. This is a debt repayment that is backed by our assets, such as a home or car loan. If we do not make our payments for these on time and in full, the lender can repossess or foreclose. That is bad for us because we lose things that are very important to us, and bad for our credit.
If we owe a substantial amount of money on our homes, it may not make sense to try to pay them off before we pay off other loans and credit cards. Home loans have lower interest rates anyway, so it is okay to postpone paying them off until we get rid of debt with higher interest rates. Just be sure to pay at least the minimum payment each month.
Paying off your auto loan is a good place to start. It will help you get rid of a secured debt, and the interest is often substantial, although probably not as high as your credit cards. You could put all of your extra money toward your car payment until it’s paid off, or you could put a portion of it toward the credit card or personal loan with the highest interest rate. If you have other secured debts, deal with them before moving on to the unsecured ones.
Once your secured debts are paid off, go through your unsecured debts in the order of highest interest rate to lowest. Pay the minimum payments on everything except the one with the highest interest until it is paid off, then move on to the one with the next highest interest rate. Repeat until they are all paid off.
When you are done with the credit cards and loans, pay off any accounts you have outstanding with service providers and such. This includes doctor and dentist bills, and anything else you have a balance on. If you owe doctors or others whose services you need on an ongoing basis, you may need to move this up on your priority list.
And finally, pay any family and friends who you owe money. They are usually more patient than regular creditors, and they will not report you to the credit bureaus. Throw in a little interest for their trouble. You should be able to afford it now that you have paid off all your other debts.
If you have a mortgage payment, now is a good time to pay extra on it. Doubling up on your payments can get it paid off many years sooner than it would be otherwise.
What to Do with the Credit Cards When They are Paid Off
Once your cards are paid off, it can be tempting to start charging again – but remember – you are on the path to being debt free now. So that is the worst possible thing you could do. There is some disagreement as to the best course of action. Here are the things you could do, along with their pros and cons.
* Keep your cards and do not use them. Some experts recommend that you keep accounts open to improve your credit rating. This can help, but if you are not using the cards, it will not help much. And by keeping the cards, you open the door for temptation. This could also backfire if an identity thief gets his hands on your card number, because you might not detect fraud until it’s too late if you’re not inspecting your bills as closely as you did when you used the cards.
* Keep your cards and use them occasionally. This will build up your credit rating if you pay the balances in full each month. But still, by keeping the cards you could be tempted to run up the balances again, putting yourself right back where you started.
* Close all accounts except for the one with the lowest interest rate and use it sparingly. This is a popular option. It allows you to have a card to use in case you really need it and to improve your credit rating, yet you do not have multiple cards tempting you. But even when you only have access to one credit card, it is possible to get into more debt than you can handle. If you are offered a credit limit increase, turn it down until you get a handle on things.
* Close all your accounts and do not look back. The only sure way to stay out of credit card debt is to not have access to any credit cards. If you are concerned that you might not be able to help yourself, this may be the best thing. Keep in mind, however, that using credit cards responsibly can build up your credit rating, making it easier to get good rates on loans for necessities in the future.
What to Do if You are in Over Your Head
What if you have tried to make a budget to pay off your cards, but the money to pay them off just isn’t there? Well, you have a few options.
Start bringing in more money. You might need to get a second job, or search for a new job, a better paying one. There are also some ways you can make extra money from home, such as dog walking or freelance writing. Start a blog or make that TikTok account make some cash for you! If it comes to this, putting as much of the additional funds as possible toward paying down your debt will help you get it down to a manageable level quickly.
Attempt to negotiate with your creditors. If you talk to your creditors, some of them may be willing to give you more time to pay, drop late fees, or reduce your interest and your minimum payment. It’s possible that they might even settle for a lower amount than you owe, although it’s rare to achieve this without a lawyer.
Consolidate your debt. Home equity loans, or second mortgages, are often used by people who are in an unmanageable amount of debt to consolidate the debt and reduce interest charges and monthly payments. The trouble is that by doing this, you put your house on the line. You may also pay more in interest than you realize, because even though the interest rate is lower, you will be paying for a longer time so always read the fine print and know what you are getting into.
If you choose this route, paying more than the minimum payment each month will save you money. It is also possible to get a credit card with a high credit limit and lower interest to transfer existing balances to. Your minimum monthly payment should also be lower. This is less risky than putting your house on the line, but you will pay more interest. If you choose either of these methods, do not fall into the trap of using your cards again. That would defeat the purpose of consolidating and get you in even more trouble.
Talk to a credit counselor. Credit counseling can sometimes help those who have taken on too much debt. A good credit counselor will negotiate with your creditors, getting you lower interest rates and lower monthly payments. Then you will make one payment each month to the credit counseling agency, which sends the lower monthly payment to each creditor, keeping a specified amount as a fee.
It is important to make sure you understand all terms of the agreement when you obtain the services of a credit counseling agency. They should tell you how soon your debt will be paid off and how much you will save in interest. It’s also a good idea to check the agency out with the Better Business Bureau to find out if there have been complaints against them.
File for Bankruptcy. This should be your last resort. Chapter 7 bankruptcy wipes all your debts clean, but you may lose some of your property depending on your individual circumstances. Chapter 13, which is now more common because of changes in the law, sets up a court-ordered payment plan to pay off your debt. Either type will stay on your credit report for 7 years, and on public record permanently.
Don’t Forget to Think and Feel Positive About Your Finances and Debt
Want to attract more prosperity and abundance into your life? You have to be positive about it. It’s easy to feel overwhelmed and stressed when you’re struggling to make ends meet or are in debt. But if you want to change your financial situation, you need to start by changing your attitude. It will not happen overnight but if you work at – you will be eliminating debt, saving money, and be able to live debt free.
When you’re feeling negative, it’s difficult to take action or think positive thoughts about your finances. However, when you focus on the positive and think optimistically, you’re more likely to take steps towards improving your situation.
One great way to start is by changing the way you talk to yourself about money. Instead of thinking of yourself as someone who is bad with money, start thinking of yourself as someone who is learning and growing.
Remind yourself that you are capable of managing your finances and creating a better future for yourself. Visualize what you want your financial situation to look like and focus on the positive steps you can take to get there.
Another important thing to remember is that you need to be positive about your debt as well. Don’t beat yourself up about the money you owe – focus on the positive things you can do to reduce your debt and improve your financial situation.
Being positive about your finances and debt is an important step on the road to creating a better future for yourself. So don’t forget to think and feel positive!
Use these powerful thoughts and mantras if you want to become rich and take control of your financial future!
- I am learning and growing, not bad with money.
- Every day I learn and grow.
- Learn and grow every day!
- I’m learning and growing each day.
- One more step towards my goal!
Debt Is not Always a Bad Thing – Really!
When managed properly, debt can be a good thing. Debt can get us an education, a new car, a house to live in. It is when we start living beyond our means that it becomes a bad thing.
By borrowing wisely and paying debts off promptly, we can keep our debt under control and become DEBT FREE! We can keep our credit scores in good shape, allowing us to get low interest rates when we need to borrow in the future. And we can life a much less stressful life when our personal finance is done right.
If you see your finances taking a turn for the worse, taking on more debt will only add to the problem. Stop using the credit cards and take steps to reduce your debt as quickly as possible. Averting disaster is often easier than we think if we are willing to tackle the problem head-on instead of letting it spiral out of control.
It is not always easy to get out of debt, but it can be done, and I have done it myself. I am sure You have made a lot of progress and tackled some big problems in your life, and you can do this too. I hope I have given you some useful tips on how to save money, build credit and at the same time – stay out of debt, so now I want to hear from you!
What are your favorite methods for staying out of the red? Share them with us!