When many people see the word “debt” they look at it in strictly a negative context. Debt to many is always a bad thing, but the reality is that debt is sometimes a necessary thing that is not bad. Three simple examples are incurring debt to buy a home, to go to college, or to start your own business. These are three business transactions that go on every day, and if used properly will increase your income and net worth over the long term.
Because debt can be a positive factor in your financial life, it is important to look at how you should handle your finances when you make the decision to take on debt. But you have to avoid the debt mentality of taking on debt simply because you can and want more, rather than going into debt as a part of a long term plan. So the starting point is to have a plan for every dollar of debt you accumulate.
Now we move to the list of 10 things to never do by showing you what you should do.
1. Waste money.
Credit card debt is at an all-time high for American households, and a simple look at how much of that money is spent on things people don’t need but instead want, will show you how easy it is to waste money. The difference between a manageable level of debt and debt that is killing your budget is the amount you waste. A look at your own finances will show how much of the debt has been incurred because of impulse purchases or making the biggest mistake with credit cards – thinking that your credit card is actually your money. It’s not. It’s the bank’s money that you not only owe to them, but they charge you interest to use that money, which increases your debt every month. Money you have to spend on credit card bills is money you cannot save or invest, so it is wasted money.
2. Fail to add to your savings.
Debt is supposed to be managed, and many people end up playing catch up with credit cards or other debt because they have overextended themselves. Rather than stick with their savings plan they divert some or all of the money to pay down credit card bills faster. This is a huge mistake because a credit card limit can be reduced by the bank at any time, for any number of reasons. Cash in the bank is … cash in the bank and can be used for any purpose. Most of all, you won’t be paying interest on that money but instead be making interest on that money. It is better to get 1% a year than to pay someone else 15% or more in interest every year.
3. Become overwhelmed by your situation.
Most people become nervous when they see their debt levels rising and everything financial going on around them seems to be standing still. It is easy to develop a defeatist attitude become frustrated, and find yourself mentally overwhelmed by the situation. The basics of finance are you have X number of dollars coming in and Y number of dollars to pay in expenses and to pay off debts. Keep things simple and see how you can increase X (the money you make every week or month) and Y (that debt number that keeps you awake at night. Most people realistically can’t do much about expenses (rent, food, utility bills) so the focus needs to be on reducing the debt level. It can be done with a focus on planning.
4. Take on more debt than you can handle.
Remember, this list is looking at debt as a positive thing if used correctly. Having debt is not the problem, but getting in over your head usually ends up being a huge problem. One example of how to avoid drowning in debt is the infamous student loan. Let’s say you calculate your current student loan monthly payments to be at $300 a month 6 months after you graduate. You have another year left to pay tuition and fees for, and can take out a student loan to cover the costs, but by doing so your monthly payment will rise to $400 a month, a number that is unmanageable for you. The easy way (never, ever do this) is to take out the student loan and worry about the payments later. The less palatable option is to stop going to school for a year and work to finance your final year of college by working. There are other choices, but adding to your debt creates a situation you cannot financially handle.
5. Ignore your budget.
Your budget is your lifeline to managing your debt. Ignoring it just because you have a large amount of disposable income is a recipe for long term financial disaster. One reason is that you are more likely to waste money (see #2) but a bigger reason is that doing the minimum will almost definitely cost you money in the long run. Simply look at your credit card statement and see how much you will pay the bank by making the minimum payments versus increasing your monthly payment by $10 or $20 a month. One reason that the amount of credit card debt is so high is because people get “comfortable” with their financial situation and accept debt as a normal part of life. It’s not, and if you are in debt you need to see ways you can save more while simultaneously reducing your debt level with the extra monthly income.
6. Become financially stagnant.
This item means that you need to understand the only way to get out of debt is to pay it off. Where the money will come from to pay off the debt is the underlying problem. If you have the opportunity to make extra money by doing some part time work or creating a passive income, it may take up some of your time but you will have an increase in your income and can pay down your debt faster. You can also choose to put the extra income into a savings or investment vehicle. Staying financially stagnant will only hurt you in the long run.
7. Failing to create a new plan.
This is connected to ignoring your budget. The New Year exists for more than a few days off from work. It is a point where you can look backwards at your debt situation and see whether you have made progress forward or your debt levels have become worse over the last 12 months. If it has improved then you can adjust you budget to direct more money into savings. If it has gotten worse, then you need to create a new plan that will reduce your debt level by the end of the year. Keeping the same plan when your dent levels are increasing is a clear path for financial disaster.
8. Skip a monthly payment without a plan.
There are hundreds of financial websites out there that will tell you skipping a payment is a huge mistake. But remember, we are looking at debt in a positive light, and amazingly your debtors want your business. There are times when life just happens and your monthly income falters. Ignoring the payment is worse than ignoring your budget. Pick up the phone and call your debtor(s) and work with them to create a reasonable plan to get you back on track. This is a better approach than immediately hitting the panic button and pulling money from savings (Just don’t tell the debtor you have $5k in savings). Tell them the truth, that you have had a monthly shortfall of income and you want to make arrangements to catch up within 60 days. In most cases it will not hurt your credit score and will give you time to get back to a normal financial situation. A warning: if you do this once too often you will likely find it creates more problems than solutions.
9. Robbing Peter to Pay Paul.
This old adage applies when you decide that applying for and receiving a new credit card with a sizeable credit line will stave off the current debt problem. You can use the credit card to do several things: take out a cash advance, do a balance transfer, or adjust your budget to use the new credit card for expenses and free up cash. Even with a 0% APR for 12 or 18 months, debt is still debt.
10. Allow your debt to manage you.
This more of a psychological problem with debt, but many times it is the root of the problem. It is easy to fall into this trap because the reality is that you do owe the money. What many people who have filed for bankruptcy will tell you is they fell into this trap. If they had filed for bankruptcy much earlier, they would have been on their way to financial recovery much sooner. This is not suggesting or encouraging bankruptcy as a solution to your debt problem, but it does say a lot about how the wrong mindset towards debt can make your situation increasingly worse. Stay positive and stay in control of your situation with the right attitude.