2014 Debt Freedom Report: Living Debt Free
America is a land of freedom and opportunity. At least that’s what we celebrate each July 4th as we watch fireworks sparkle over waving stars and stripes. But there are many different types of freedom and numerous instances throughout history in which our actions have belied our ideals. One thing in particular from which we are not free at the present time is debt. Millions of Americans owe trillions of dollars to various types of lenders, and even Uncle Sam is deep in the hole.
There is plenty of blame to go around for this beholden state of affairs, from corporate shenanigans and questionable political leadership to a lack of financial literacy and the gradual transformation of old-school luxuries into new-school necessities.More important than how we got here, however, is what we’re going to do about it now.
The ideal approach is neither to continue our old overleveraging ways nor to swear off all manners of debt forevermore. Those are merely opposite extremes of a debt-dictated lifestyle, asone’s refusal to get a mortgage or a business loan, for instance, couldeachserve to delay the American Dream in its own way. True debt freedom instead entails wielding leverage with responsibility and purpose, rather than out of necessity or foolishness. It requires the discipline to borrow only for appreciating assets and when it’s truly affordable as well as the wherewithal to adjust youroverall saving and investment strategy as your station in life evolves.
Ultimately, while neither becoming debt free nor sustaining a debt free lifestyle is easy, both are eminently noble goals. And that is precisely why WalletHub would like to humbly offer some tips, information and resources in support of your pursuit of financial independence. After all, if we all work together, our societal addiction to debt can indeed one day be beaten.
Debt is one of those things that’s alright until it isn’t. You can skate by for a while on minimum payments or under introductory terms – perhaps even convincing yourself that it’s sustainable – but then that balloon payment inevitably pops up or your income disrupts or interest simply gets out of hand. The Great Recession reacquainted the public consciousness with the dangers of debt and the folly in a hope-for-the-best approach to personal finance. And while credit card debt trends showed that we learned our lesson in the immediate, anemic aftermath, a recent reversal in course and our overall body of work has to make you wonder: did anything stick? Just consider the current state of affairs:
|National Debt (as of June 2014)||$17.5 trillion|
|Credit Card Debt (as of Q1 2014)||$801.3 billion|
|Student Loan Debt (as of June 2014)||$1.2 trillion|
|Individual Bankruptcy Filings (2009 – 2012)||~ 7.5 million|
|Number of Foreclosures (2009 – 2012)||~ 13.5 million|
- It’s Cheaper: Debt obviously comes at a significant cost, and the more you rely on it, the more expensive it becomes. The same principles of compound interest that enable early savers to accumulate a great deal of long-term wealth work against you when you’re constantly playing from behind. Finance charges incur finance charges, minimum payments rise, and things can quickly become unsustainable.
- It’s Less Stressful: Americans are becoming increasingly stressed, according to the American Psychological Association, and the effects can be corrosive to our mental, physical, and financial health. The primary causes of this stress: 1) money; 2) work; and 3) the economy. Having to constantly scratch and claw to make monthly debt payments exacerbates this high-stress state of affairs, potentially resulting in physical and mental illnesses that can drive up costs and make it even more difficult to get back in the black.
- You’ll Have a Better Retirement: The sooner you can divert funds away from debt payments and into a retirement account, the better. Time is your biggest ally when it comes to retirement planning. It enables you to benefit as much as possible from compound interest and negates the need to take unnecessary investment risks as you get closer to the age at which you’d like to exit the workforce.It’s human nature to prioritize the tangible now over the distant future, but if you can try to empathize with your future self and consider the quality of life you’d like to have, you’ll be less likely to rob from yourself in the short term.
- Debt Dictates Lifestyle: Taking on a significant amount of debt can limit the options available to you in various aspects of life, from the types of jobs you can afford to accept and what you’re able to do during leisure time to even your ability to leave a dysfunctional relationship.
- Figure Out Where You Stand: The first step in freeing yourself from debt is getting a clear sense of your starting point. So, gather all relevant documentation – including all of your latest bank account and credit card statements, pay stubs, etc. – and determine exactly how much you owe, the rates of interest you’re paying, and how much money you have coming in each month. This will enable you to make a plan of attack.
- Use a Debt Free Calculator: While optimism is great, a hope-for-the-best attitude is not going to pay off your balances and usher in debt freedom. Rather, it’s important to devise a realistic, commonsense plan that will get you out of debt by a particular time as a result of steadily chipping away at your debt each month. A debt free calculatorwill help you determine how much interest is costing you, how long it will take to pay off your balance based on different monthly payments, and even if there isa credit card deal available that will save you money.
- Visit a Non-Profit Credit Counselor: Efficiently eradicating debt often necessitates making the types of tough choices that can benefit from a fresh perspective and a bit of expertise. As such, you shouldn’t be afraid to ask for help. The best sources for such information are typically non-profit credit counselors and university-sponsored clinics, as they’ll be inexpensive (often free) and impartial. You don’t have to listen to everything they say, but you can ask questions and at least gather some potentially helpful information.
- Make a Budget: A well-thought-out budget is the centerpiece of any plan to reach debt freedom. The best approach is to make a list of your monthly expenses (based on previous months’ bills) and cut as much of the fat as possible in order to make room for increased monthly debt payments and savings contributions. This process will be difficult, as it will likely require certain sacrifices and the redefinition of necessities into luxuries, but you’ll find that it will all ultimately be worth it.
- Evaluate Your Career: Sometimes, no matter how much we scrimp and save, we simply cannot make any significant dent in our debt given our current earning potential. Addition becomes just as important as subtraction in such situations. In other words, you may need to consider ways to supplement your income – such as switching employers, entering a new field and getting additional education – in order to make ends meet in the long run.
- Explore Your Other Debt Solutions: Depending on how much debt you’ve accumulated and the state of your credit history, the debt solutions at your disposal may range all the way fromtransferring a balance to a 0% credit card to entering into a debt management plan to speaking with a bankruptcy attorney.
- Stick to That Budget: A budget is not a tool only for exorcising your debt demons. It should be employed on an ongoing basis and adjusted based on changes to your income or monthly expenses. Most importantly, it should serve as reference point, enabling you to compare your actual personal financial performance to what you’ve planned in order to make sure you stay on the debt free path moving forward.
- Build an Emergency Fund: True debt freedom is not complete without an emergency fund. Otherwise, you’re just an unexpected major expense or income disruption away from having to borrow to get by. Ideally, you should gradually save around a year’s worth of take-home pay in order to insulate your household finances from the future unknown.
- Remove Temptation If Necessary: You shouldn’t give up on credit entirely just because you want to live a debt-free lifestyle. There are many reasons to use a credit card, chief among them being plastic’s conduciveness to credit building. That’s important because the influence of your credit score extends well beyond debt, to your car insurance premiums, job prospects, housing options, etc. And because you don’t actually need to make purchases with a credit card to build a good credit score, you can always cut up your card or lock it in a drawer in order to benefit without the temptation to overspend.
- Use the Island Approach: The Island Approach is a credit card strategy that involves using different cards for different types of transactions in order to save money and promote financial clarity. The centerpiece of this strategy is typically an everyday spending card that should be paid off in full every month. If ever you fail to do so, you’ll know that you’re spending too much and need to cut back.
- Automate Payments: Sometimes debt is borne from simple forgetfulness, such as failing to pay a bill on time and thereby incurring finance charges and potential credit score damage. Setting up automatic monthly payments from a bank account – for the minimum amount required, your full balance, or a custom amount – will help you remain in good standing as well as give you one less thing to worry about.
- Take Advantage of Rewards: Folks who pay for things exclusively in cash effectively subsidize the expenses of those who use plastic, since prices are typically the same and everyone therefore helps foot the bill for payment processing and rewards programs. You can maximize this inherent plastic-borne price advantage by making a rewards card that offers attractive earning rates in your biggest everyday expense categories your primary spending vehicle and paying your bill in full every month. Occasionally supplementing what you earn with a lucrative initial bonus can be very beneficial as well.
- Save Early, Often &For Specific Reasons: Putting your money to work and allowing compound interest to work for you rather than against you is the easiest way to accumulate long-term wealth. Setting specific spending goals (e.g. retirement, college or even a vacation) and allocating funds in different accounts will make it easier to track your progress, garner various tax benefits, and manage your liquidity.
- Invest Wisely: You don’t need to be a genius to benefit from the stock market. You just can’t be reckless or greedy. Most people are best off with a low-cost mutual fund or ETF that mirrors the S&P 500. If you decide to pick individual stocks, remember to stay diversified and don’t try to time the market.
For more insight into the true meaning of debt freedom as well as tips for how to attain it, we turned to personal finance experts from the world of higher education. You can check out their bios and commentary below.
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