Everyone wants to know how to get out of debt. And considering that consumers have collectively racked up more than $182 billion in credit card debt since the beginning of 2011, it’s no wonder why. But while scratching and clawing one’s way to debt freedom is indeed a difficult and commendable act, staying out of debt in the long-term should be your true objective.
How does one go about ensuring they stay in the black? There are a number of strategies, as you’ll see below, and it all begins with preparation.
There is a variety of reasons why people get into debt, some intentional (e.g. student loans, auto loans and mortgages), others circumstantial (e.g. car repairs, emergency medical expenses or job loss). And while you cannot protect against all drivers of debt, you can certainly take steps to decrease your reliance on borrowed funds.
- Emergency Fund: Maintaining debt freedom without an emergency fund is like walking a tightrope with no safety net. You are only one misstep away from disaster. That’s why it is so worrisome that only 40% of Americans have emergency financial reserves, according to FINRA’s Financial Capability Study.It’s also why we recommend setting aside a couple months’ pay even before you begin seriously paying down what you owe. After you get out of debt, your objective should be to save as much as possible each month until you have at least a year’s take-home in the bank.
- Insurance: By definition, insurance is protection against potentially serious financial liability. Not taking the necessary steps to ensure you have the proper health insurance for your family, the right auto insurance for your car, and the appropriate coverage for your home is therefore tantamount to playing with fire. Sure, such plans will represent a short-term expense, but they will also shield you from far more significant costs in the long run.
- Budget: You can’t keep your spending in check if you don’t have a budget. Odds are you made one while paying off your debt, but you’ll need to readjust now that you’re out of the red. Start by reviewing past months’ bills and make a list of your recurring expenses, rank-ordered based on importance (with true necessities, including emergency fund contributions, obviously at the top of the list). Then, determine your monthly take-home and cut out any expenses that exceed that amount. After that, it’s just a matter of sticking to your plan and monitoring your performance.
- Automatic Bill Pay: Adding automatic monthly bill pay to your credit card account and other recurring expenses counteracts forgetfulness and provides peace of mind. As far as your credit card is concerned, you can choose to pay the monthly minimum, the full amount due or a customized amount. But keep in mind that minimum payments won’t help you stay debt free. You’ll need to choose the “pay full balance” option in order to ensure that.
- Earning Potential: In theory, the more income you have, the less likely you’ll be to incur debt. So, in addition to altering your spending and payment habits, you may want to consider the flip side of things as well. Perhaps you can obtain extra training or go back to school in order jump into a higher income bracket with either your current employer or a new outfit. Or maybe you could take on a part-time job, even supplementing your earnings with freelance work online. The specifics are up to you, but this is an avenue that definitely merits consideration.
Regular maintenance is one of the keys to staying out of debt. Turning a few core tasks into habits will therefore go a long way in keeping you out of the red.
- Review Monthly Bills: Reading over your monthly bills – especially those from your credit card company – is a great way to ensure your spending stays in check, to investigate for signs of fraud, and to make sure the issuer hasn’t made any mistakes.
- Pull Your Credit Reports: We are all entitled to a free copy of each of our major credit reports every 12 months. Spacing things out for the three major credit bureaus – Experian, Equifax and TransUnion – and ordering one report every four months will enable you to keep tabs on your credit building progress as well as parse your files for errors.
- Monitor the Mail: The credit card offers you receive in the mail are a great indicator of your financial situation. If, for example, you’re getting offers for rewards cards catered to people with excellent credit, it would seem that your credit score is in the excellent range and that credit card companies think you have enough disposable income to handle a new card. If, on the other hand, you’re not getting any offers at all, you’ll need to consider what might be the cause.
- Evaluate Savings & Investments: Keeping track of your various savings and investment accounts (e.g. college fund, retirement fund, general emergency fund) is necessary to track progress toward savings goals and to avoid accidental overspending.
Staying out of debt requires planning and understanding one’s own temptations. As a result, you’ll want to develop a strategy for mitigating the resurgence of bad habits and thus a repeat of your debt ordeal. Below are some common examples of such personal finance fail-safes.
- Level 1: Remove Authorized Users – Whether or not the authorized user is contributing to the overspending, it’s often a good idea to streamline troubled accounts by removing the access of others. It can be difficult to regulate spending when other people are making charges.
- Level 2: Request a Credit Limit Decrease – While it might be a tough pill to swallow, asking your credit card issuer to lower your spending limit to an amount you know you can afford based on your monthly take-home is a very effective strategy for reining in spending.Note that reducing your credit line could lead to a bit of credit score damage due to the change in your credit utilization ratio. Still, the benefit of staying out of debt outweighs this particular cost. You can also accommodatethe change by cutting back on card usage, if possible.
- Level 3: Cut the Card – Should you wish to remove the temptation of credit card use altogether and perhaps transition to a cash-only lifestyle for a little while, you can always cut up your card or lock it in a drawer somewhere. This is definitely preferable to actually closing your account because as long as you’ve settled up on your bill, your account will continue reporting positive information to the major credit bureaus every month.
You’re going to encounter a number of hurdles attempting to implement the strategies laid out above. Hopefully, the following tips will enable you to clear them with ease.
- Understand Something Has to Give: Continuing the habits that led you into debt in the first place will only lead you one place: back into debt. You therefore need to change something, whether that’s reducing the amount you spend or increasing the amount you earn.
- Put a Plan on Paper: Thinking through your goals as well as the logistics of debt avoidance and crafting a clear plan will help you foresee potential problems as well as stay on the right path in the future. Writing it down not only makes the plan real but gives you something to reference along the way.
- Save as Much as Possible: Always try to push the boundaries in terms of what you can save. This will pay major dividends as your kids grow older and you near retirement age. Every dollar you put away also decreases the odds you’ll end up back in debt,just by a little bit.An essential element to saving is choosing the right credit card(s). In addition to being the most accessible credit building tools available to consumers (which leads to lower insurance premiums, better loan terms, etc.), credit cards are now also offering lucrative initial rewards bonuses worth up to $400 and 0% intro terms for as long as 18 months.
And credit cards can either save you well over $1,000 per year or charge you an annual fee as high as $495, plus interest that could prove to be even pricier. It’s therefore important that you carefully consider your habits and needs and then find the financial products that are best suited to meet them.
- Use the Island Approach: One simple method to ensure you’re addressing all of your financial needs is to use the Island Approach. The Island Approach is a strategy that advocates using separate accounts for each of one’s primary objectives.For example, this might entail using a rewards credit card for everyday expenses that you can pay for in full by the end of the month and a 0% credit card to avoid finance charges on a big-ticket purchase. The beauty of this is if interest ever appears on your everyday card, you’ll know right away that you’re overspending. A small business owner might also use the Island Approach by getting a business rewards card for everyday spending and a 0% consumer card for financing. This would enable them to get the unique business-oriented rewards small business cards are known for as well as the CARD Act protection that only consumer cards have been granted.
- Use a Credit Card Calculator: If you plan to make a large purchase that will take a few months to pay off, or you’re ever in need of a balance transfer, make sure to take advantage credit card calculator to determine how long it will take to cover the expense. This will enable you to find the right 0% credit card and plan the monthly payments needed to be debt free by the time regular rates take effect.
- Go to Credit Counseling: Credit counseling is a relatively inexpensive (often free) means of getting qualified, personalized financial advice. A credit counselor can help you make a budget, develop a savings strategy, and even compare home or auto loans.
- Teach Your Kids Financial Literacy: Financially literate children tend to waste less of their parents’ money as well as make more informed college choices (also potentially saving money). They’ll be in a better position to take care of you financially when you’re older as well.
Ask the Experts