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How to Avoid Debt
By Nicole Symon MONEY RESEARCH COLLECTIVE
The total household debt in the U.S. is $16.9 trillion, according to the Federal Reserve Bank of New York. Just because having debt is common doesn’t necessarily mean that it’s healthy — especially if you have too much debt. Debt can strain your finances and limit your ability to achieve future goals, like homeownership or retirement.
If you’re trying to reduce or avoid debt entirely, there are some strategies you can take and things you should avoid. Below, we detail the top tips so you can avoid debt whenever possible.
Best tips for reducing debt
The best tips for reducing debt break down into two main categories: the dos and the don’ts. The dos — things you should do to avoid going into too much debt — include sticking to a budget and using an expense sheet. On the other hand, there are common mistakes to avoid that can lead to excessive debt, like neglecting your credit score and waiting to pay off your credit cards.
The dos
Whether you’re dealing with tax debt, medical bills, student loans, credit card debt or any other type of debt, there are some strategies for reducing debt that you should apply. Make sure you take the following measures on your debt freedom path.
Be thoughtful when making purchases with your card
Some people don’t think twice about making purchases on their credit cards, regardless of whether they have the funds to cover those purchases. This contributes to your debt. Instead, carefully consider whether you can afford to pay for your credit card purchases. Remember that you will have to pay back the total amount quickly. Otherwise, you’ll go into credit card debt and pay money on interest.
Create a budget and stick to it every month
One of the tried-and-true ways to avoid debt is to create and stick to a budget every month. Your budget will help you live within your means and avoid overspending. First, calculate your monthly income and subtract all your monthly expenses and debt. If you end up with a negative number, you’re outspending your monthly income.
To create a personal budget, sort your spending into three categories: essential, nonessential and savings or debt repayment. Using the popular 50/30/20 budgeting method, you should allocate 50% of your income to essential expenses like rent and transportation, 30% to nonessential expenses like entertainment and 20% to saving or paying off your debts. Adjust these percentages as necessary, but stick to your budget to avoid overspending.
Utilize an expense sheet
Though expense sheets are typically associated with businesses, you can also use one to manage household expenses. List all your essential expenses on a sheet with a short description and amount for each. You can update this list each month if your costs change. Seeing all your expenses in one place will give you a better idea of where your money’s going and where you can cut back.
Save for emergencies
Not having an emergency fund is a common reason people fall into debt unintentionally. At any moment, an emergency can strike, such as damage to your home or a sudden need for medical care. If you don’t have an emergency fund available to cover those costs, your only option will be to take out a loan, plunging you into debt. You’ll end up paying interest and other fees on this debt that an emergency fund could have helped you avoid.
Start saving for emergencies as soon as possible, even if you can only afford to put away a small amount, like $25 or $50 each month. Every little bit helps. The general guideline is to save three to six months’ worth of your typical monthly expenses in your emergency fund. Setting aside this much will help you cover most unexpected financial emergencies, so you don’t have to take out loans when they occur.
Use cash more often
Every time you pay with a credit card, that purchase adds to your outstanding debt. Instead of relying on your credit card for all your purchases, use cash more often. Using cash gives you a concrete idea of how much money you can spend. If you don’t have enough cash to cover a purchase, you can use that as a sign to consider whether you can afford the item or service.
Using a credit card makes it easy to spend money you don’t have. The best way to avoid credit card debt is to avoid making purchases you couldn’t afford in cash.
The don’ts
There are certain things to avoid if you’re trying to stay out of debt, such as waiting to pay off your credit card and taking out cash advances. Avoid these costly mistakes that can get in the way of eliminating or reducing your loans:
Avoid taking out too many cards
How many credit cards are too many? For some people, one to two credit cards is enough. For others, six cards or more is ideal.
While there’s no hard or fast rule for determining the “right” number of credit cards, you want to avoid taking out too many cards. In general, you may have too many cards if you struggle to keep track of your payment due dates, annual fees and rewards.
If you already have credit cards, it may be wise to resist the urge to open new ones just because you received an attractive introductory offer or meet the minimum income requirements. Credit card companies often bombard college students with offers, for example. If you want to know how to avoid debt in college, don’t respond to those offers and open too many new cards. Part of avoiding credit card debt is keeping your number of cards manageable.
Don’t wait to pay off your credit card bills
When you receive your credit card bill, you’ll see the minimum payment and the due date for making that payment. If you don’t make the minimum payment by that date, your credit card company may charge you higher interest rates and late fees, and your credit score may decrease. Don’t put off making your monthly payments until they’re due to avoid these issues.
If you wait until the last minute to pay your bills, you’re much more likely to forget or encounter another issue leading to a costly late payment. Try to pay your credit card bills as soon as possible, ideally when you get them. Another option is to set up automatic payments so you never miss one.
If you can, make more than the minimum payment on your bills. Making only the minimum payment keeps your account in good standing, but it will take you much longer to pay off your debt this way. You’ll also pay more in interest. One of the best ways to avoid credit card debt is to pay your balance in full each month before the due date.
Don’t rely on cash advances
A cash advance is a withdrawal you make in cash against the credit limit on your credit card. Your credit card typically allows you to withdraw a certain percentage or flat figure of your credit limit in cash. For example, if your card has a cash advance limit of 30% of your $5,000 credit limit, you can take your card to an ATM and withdraw up to $1,500 in cash. However, this option contributes to your debt.
You should never rely on cash advances because they typically come with costly fees that outweigh the benefits. For example, the cash advance annual percentage rate (APR) is generally much higher than the standard purchase APR on your card. Be advised that these interest fees will usually go into effect immediately, unlike regular purchases, which have a grace period. You may also be subject to cash advance fees and separate ATM or bank fees. All these costs add up to make cash advances very expensive and risky.
Using a cash advance should be your last resort in a financial emergency. If you can, before taking out a cash advance, consider borrowing from friends or family, or taking out a personal loan. Either of these options is likely safer than a cash advance.
Don’t neglect your credit score
Your credit score is a vital part of your financial health. Lenders use it to evaluate your loan eligibility and decide the terms you receive. In addition, insurance companies may use it to determine your rates and landlords may consider it for tenant screening. Given its importance, you should never neglect your credit score.
Check your credit score regularly to get a handle on your current credit position. You can check your score for free once annually with each of the three major credit bureaus at AnnualCreditReport.com.
One of the common credit score myths is that all three of these bureaus calculate your credit score the same way, but they don’t. You should request your score from each one for a complete picture of your credit position. Look for any inaccurate or incomplete details in your credit score and correct them as soon as possible to ensure your score is up to date.
If your score is lower than you want, you can set goals for improving the weak points that are bringing your score down. Five main categories inform your FICO credit score: your payment history, the amount you owe, the length of your credit history, recent credit inquiries and the types of credit you use. By lowering your outstanding debt, for example, you can increase your credit score.
Don’t take out loans unless it’s necessary
Sometimes, even when your goal is staying out of debt, you may feel pressure to take out a new loan. For example, a financial emergency could occur, and you might have no other way of covering those expenses. Or, you might need to pay for your college education with a loan. Whatever the case, part of avoiding debt is not taking out loans unless you have to.
Before taking out a new loan, consider all alternatives. Do you need to make the purchase(s) you plan on using the loan for? If so, could you reduce your expenses or increase your income to cover that cost? Only take out a new loan if these alternatives aren’t viable.
If you have no other option, look for the financial institution offering the most favorable loan terms to make your debt repayment more manageable. And be aware of debt traps, such as taking out new loans to pay for your existing loans. Making this move can lead to a damaging cycle that keeps you in debt even longer.
On the other side, if you get a financial windfall, you may be tempted to pay off some of your outstanding debts, like your mortgage. So, should you pay off your mortgage early? While this will eliminate your mortgage payments and increase your cash flow, it may decrease your credit score. You’ll have to weigh the pros and cons of your unique situation.
Use the right tactics to minimize or avoid debt altogether
You can keep debt from interfering with your financial security. Remember to apply these tips to minimize or avoid debt entirely:
- Pay with cash instead of credit whenever possible.
- Build an emergency fund with at least three to six months of your expenses.
- Keep an eye on your credit score.
- Don’t take out extra credit cards or loans unless it’s necessary.