Five things you can do to stay in the black.
Are you one of the 20 percent of American households that spend more than they make? One of the 44 percent of credit card holders who carry a balance? Or one of the 7 percent of households that have a loan payment 30 days or more past due?
Many consumers have developed poor spending habits that rack up bad debt in the form of large credit card balances, secured and unsecured personal loans, second mortgages, and so on. To help combat this trend, we've identified five things you can do to start forming new spending habits that will better position you to become debt-free.
No matter what your scenario, there are some habits you can develop to learn to live debt-free.
1. Pay down debt as quickly as you can.
There are several approaches to paying down debt: Either start with the smallest balances first and move on to larger balances later, pay off the debts with the higher interest rates first and lower interest rates later, or combine the two options. Which one is right for you? That depends on your financial situation. Here are some factors to consider:
- Paying off debts with a smaller amount first will provide you with quicker "wins" and can keep you motivated. It feels good to cross a debt off your list and you'll do that sooner by focusing on those debts with smaller balances.
- Paying off debts with higher interest rates may take longer to get results, but if you run the numbers, you'll usually save more money in the long run by using this approach. The balances you owe, combined with interest on the debt, will affect which debts you should pay down first to pay the least amount of interest. Bankrate.com has a calculator to help you determine which debts to pay first and how much the payments should be to maximize your efforts.
A hybrid method might appeal to your emotions to get you jump started by quickly paying off a small debt, then attacking a high-cost debt to appeal to your logic by reducing your interest cost in the longer term.
2. Pay with cash when you can.
Paying with cash is not always an option, but if you are able, it will save you interest on paying off those items later. Avoid using credit cards for most consumer purchases, unless you plan to pay off the balance quickly. Otherwise, your groceries, gas, clothing, and household goods may cost you several times more than their original value. Even taking advantage of a discount by using a department store card could cost you more in the long run if you don't pay off the balance before the accrued interest grows larger than the discount you got at the register.
3. Stash your cash when you can.
Life happens when you least expect it. It's not uncommon for unplanned purchases to take us by surprise and put us further into debt. Flat tires, vehicle or home maintenance, medical emergencies, and other unexpected situations can tap into our finances quickly. Rather than putting the bill on a credit card or getting a payday loan, a small emergency fund of even $500 can help cover unexpected expenses and avoid the need to turn to a credit card.
The sooner you can build an emergency fund, the better. If you place $10 a week into a savings account, you'll have more than $500 saved by the end of the year. If an emergency pops up, be sure to replenish the account as quickly as possible.
4. Keep your spending in the can.
While the thought of earning a higher paycheck over time will help you get out of debt, there's a habit that may impede your ability to do so: spending frivolously. Keep track of your daily spending habits for at least a month and look for items that were discretionary purchases (see our "3 steps to a better budget" article for resources). Ask yourself: Did I really need to purchase that? Cut back where you can, spending your hard-earned money only on essentials, especially if you are in debt pay-down mode.
The sooner you can build an emergency fund, the better.
5. Earn more if you can.
If you can get a promotion, start a new job at a higher wage, or land a second job, you would have extra money to pay down debt and cover your expenses. But that's not always possible. Here are some other options to boost your income or reduce your expenses:
- Sell a large item to help pay off a big debt.
- Change your transportation habits, such as using public transportation or carpooling, saving on your gas bill and possibly a car payment.
- Have a garage sale to earn extra money while you declutter.
- Rent a room in your house or get a roommate to share housing costs.
- Downsize and move into a less expensive home.
Is there such a thing as "good" debt?
While most debt is considered to be bad, there is "good" debt to have. For example, student loans and mortgages can be considered good debt, because you're investing in your education, which should help your career and increase your income level over time. As for a mortgage, the value of your house and land should also increase over time, making it worth more than your original purchase price.
There are plenty of strategies and resources for getting yourself out of debt. The important part is finding one that works for you and sticking to it.