Freedom from debt is a common financial goal, and with good reason. After all, being in debt is expensive. And it can leave you feeling trapped as you’re forced to continually earn money to send payments to creditors.
Unfortunately, being in debt is a way of life for many Americans, and the debt trap is one you’ll never get out of unless you change these five troubling habits.
Continue Reading Below
1. Paying only the minimums on your credit cards
Making minimum payments on your credit cards is a surefire way to stay in debt forever. The minimum payment likely barely covers the cost of interest, which means your principal balance hardly ever declines with each payment you make. The result: It takes years to pay off what you owe.
Say, for example, you have a $5,000 credit card balance on a card charging 15% interest. If you make a minimum payment equal to the lesser of 2.5% of your balance or $15, you’ll be making payments for 18.75 years. Over all this time, you’ll pay $4,636.92 in interest — nearly doubling the cost of the purchases you made to run up that $5,000 balance.
Clearly, continuing to pay a credit card off for almost two decades isn’t a wise financial move — but it’s the situation you’ll find yourself in if you don’t pay a lot more than the minimum due.
2. Taking out high-interest consumer loans
Advertisement
Credit cards are hard to pay off because they have high interest rates. But they actually aren’t the worst debt you could take on. Payday loans, car title loans, and personal loans with extremely high rates are worse. Payday loans, in fact, can have an effective APR of around 400%.
Avoiding loans with exorbitant interest is essential if you ever hope to become debt-free. Make sure you understand the terms of any loan you take out, and ensure the annual percentage rate is reasonable when taking both interest costs and loan fees into account.
If you’re already stuck with high-interest debt, see if you can take out a personal loan or use a credit card balance transfer to lower your interest rate. You’ll need reasonable credit, or a cosigner to do this, so it may be hard if you’ve turned to payday loans or a car title loan due to bad credit. You should also look into all your options when borrowing, as there are better alternatives, such as payday alternative loans from credit unions that can provide fast access to cash when you really need it.
3. Borrowing money for depreciating assets
If you want to become and stay debt-free, limit the types of situations in which you borrow.
Sometimes taking out a loan is necessary and can even make financial sense. That’s the case when you borrow for a home or to attend school. Mortgages and student loans are typically considered good debt because the interest rates are usually reasonable and your home or education usually helps you to increase your net worth over the long term.
But borrowing money for things that quickly — or immediately — lose their value can leave you constantly stuck with payments without any resulting increase in net worth. If you borrow for groceries and vacations, for example, you’ll have nothing to show for the debt you owe. And you may keep having to borrow forever unless you can find an alternative way to pay for this stuff, because vacations and groceries and clothes don’t last — unlike a home or your degree.
4. Not having a debt payoff plan
Far too many people with debt don’t really like to think about it and don’t have a big-picture view of how to become debt-free. If that’s the case for you, you’re probably going to be stuck in debt for much longer than you should be.
There are two common techniques for paying off debt: the debt snowball and the debt avalanche. Both involve making extra payments, but the snowball method involves paying off debt with the lowest balance first and the avalanche method involves paying off higher-interest debt first.
If you’re serious about becoming debt-free, pick one of these payment plans — or find a plan that works for you. Figure out all you owe and which debts you want to focus on paying off, and start working on your plan so you can free yourself once and for all from the creditors you’re currently working to enrich.
5. Living without an emergency fund
If you don’t have money set aside for emergencies, it’s inevitable that you’ll end up in debt when those emergencies occur. Living without savings creates a cycle where you try to get out of debt and are constantly set back when some unexpected expense crops up and you have to borrow. That’s why it can be important to save up an emergency fund even before making tons of extra debt payments.
Ideally, you should save enough to cover three to six months of living expenses. But if you want to focus on debt repayment before saving a fortune, start with a mini emergency fund of around $500 to $2,000. That way you have this money to rely on when you need it and won’t get deeper into debt after you’ve begun the payoff process.
Break these habits so you can become debt-free
Now you know the five key habits that are holding you back from becoming free of creditors. Hopefully, you can make a debt payoff plan, start saving an emergency fund, and stop taking on debt that’s difficult to pay off. If you can do these steps, you’ll be in a much better financial position, and your money will be yours to spend instead of being wasted on interest.
The $16,728 Social Security bonus most retirees completely overlook If you’re like most Americans, you’re a few years (or more) behind on your retirement savings. But a handful of little-known “Social Security secrets” could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more… each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we’re all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.
