WHAT TO DO WITH BAD DEBTS ON YOUR BOOKS

The debt problem in the United States is bad, and it keeps getting worse with every passing year. Total household debt, including mortgages, was about $132,500 in 2016, with the average household’s credit card balance hovering around $16,000. These are incredibly high, either setting new records or practically tying old ones.

Debt seems unavoidable in the current economic climate, especially for young people trying to get an education, make ends meet, and start a life for themselves. But is there a way to avoid going into debt entirely?

Prevent Accumulating Debt, Know the Difference Between Good Debt & Bad Debt

First, you should understand that not all forms of debt are “bad.” It’s true that taking on debt is usually accompanied by high interest rates, which means you’ll owe more money over time, and end up spending or owing far more than the original value of the items you’ve purchased. It’s also true that having too much debt can make it harder for you to apply for new loans, and may interfere with your life in other ways.

However, there are some forms of debt that are considered “good.” Good debts are debts you take on because their future value will eventually make your investment worth it; for example, taking out student loans to get a college education that, in turn, maximizes your income potential, will eventually make you more money than it initially costs you. Similarly, using a mortgage to buy a house can provide you with both shelter and equity, in exchange for relatively small interest payments.

Bad debt, on the other hand, yields you no future value. For example, buying a new TV with a credit card and avoiding paying off the debt will probably come back to haunt you, with no opportunity to make up for the loss—especially if you’re facing high interest rates.

Most Common Reasons for Going Into Debt

To identify the best strategies for debt prevention, we must first understand the main reasons people go into debt:

  • Irresponsible spending. Everyone has their vices, but some vices are more destructive than others. Spending money irresponsibly, whether it’s an excessive amount of money, an amount of money you haven’t earned, or money on objects or experiences that aren’t valuable, can lead you to debt.
  • Going through a divorce has the potential to seriously wreck your income and assets, depending on your positions before and after the divorce.
  • If you have a habit of gambling, one big loss or the accumulation of lots of little losses can leave you in debt.
  • Medical expenses. One of the most common ways of going into debt in the United States is through medical expenses; medical procedures are often necessary to save your life, and without a good insurance plan, they can cost tens to hundreds of thousands of dollars (which you may not have).
  • Reduced income. If an economic downturn or another unfortunate event leaves you with less income, but your expenses remain consistent, you’ll also be more likely to fall into debt.
  • Poor savings. If you have a sudden expense, but you don’t have the emergency reserves to cover it, you’ll have no choice but to go into debt to recover from it.

Debt Avoidance Strategies

So what are the best strategies for avoiding the accumulation of debt?

  • Don’t buy more house than you can afford.

    Your home is going to be one of the biggest financial decisions you make, and too many people make that decision recklessly. Just because you can qualify for a specific home loan amount doesn’t mean you should take that full amount; instead, you need to take your time and figure out exactly how much you can afford. The rule of thumb is to spend no more than 25 percent of your income on housing, though this percentage can and should change depending on your personal circumstances. To be conservative, focus on buying less house than you can truly afford, netting yourself a wider margin of error and decreasing your chance of falling into debt.

  • Live below your means.

    Your house may be one of your biggest financial decisions, but it isn’t your most common. You’ll also need to consider all the little purchasing decisions you make over the course of a month, or a year, and try to live below your means—in other words, spend less money than you can afford to spend. Sometimes, that means eliminating your subscription services, spending less money on groceries and utilities, and keeping your entertainment to a minimum. You should always have money left over every month; if you don’t, it means there are more expenses to cut, or you need to step up your income to preserve your current lifestyle.

  • Keep your credit cards paid off.

    Though it may be difficult if you’ve already accumulated some debt, try to keep your credit cards paid off as much as possible. The average annual interest rate for credit cards in the United States is 15 percent, which means you’ll pay $150 on every $1,000 in debt you hold, every year. Because that amount is compounded regularly (usually monthly), you may quickly end up owing far more than whatever items you’ve purchased are worth. Credit card debt is the most destructive and least useful type of debt you can have, so try to nip it in the bud before it starts affecting your life.

  • Use scholarships to minimize student debts.

    If you’re enrolled in college, or you’re considering attending, you should know that student loan debts count as “good debt”—this is an investment in your future. However, you shouldn’t pay any more than you have to, or go into more debt than necessary to complete your education. Look for scholarships in your current program. Get a part-time or full-time job to pay for as much of your education as you can. In most cases, you can offset at least several thousand dollars of expenses. This helps set yourself up for graduation with limited debt.

  • Build an emergency savings fund.

    Because it’s possible—and common—to go into debt due to unforeseen expenses, it’s a good idea to build up an emergency savings fund. Set aside some money every month, and don’t touch it unless you really need it; once you’ve built up six months’ worth of expenses, you’ll have a flexible barrier protecting you from things like medical bills, vehicle repairs, and other necessary, yet unpredictable expenses that could otherwise compromise your financial future.

  • Invest in good insurance.

    Don’t forget that medical expenses are one of the leading causes of debt in the United States; just one major surgery or course of treatment, if you aren’t prepared for it, could leave you with thousands of dollars of debt to deal with. It’s almost impossible to plan for these developments, but you can protect yourself against them by investing in a good insurance policy. It may cost you a few hundred dollars extra every month, but it could prevent you from going into debt unnecessarily.

  • Increase your income.

    If you increase your salary, you’ll have more financial wiggle room, and you won’t be as likely to succumb to borrowing money when you need it. Of course, practically everyone wishes they had a higher level of income, but not everyone has the motivation to achieve it. Consider asking for a raise or promotion, or investigate other job opportunities in your area. You could even pursue secondary revenue streams to diversify your income over time.

Minimizing Existing Debt

Let’s say you’ve made some mistakes in the past, and you’ve already accumulated some debt. Don’t worry—your life isn’t over. There’s almost always a way out, as long as you’re willing to commit to better spending habits. Here are a few of the sacrifices you’ll have to make to climb out of the hole:

  • Stop the bleeding. The first thing you need to do is stop the bleeding by avoiding the accumulation of any more debt. Get your spending under control with a strict budget, and if necessary, cancel some of your credit accounts. Avoid the temptation of borrowing any more, until you get this situation under control.
  • Negotiate better rates. Call up your credit card companies and see if you can negotiate better interest rates. You’d be surprised how often this can work. Even a reduction of a couple of points can spare you hundreds of dollars. Even more in the long term, depending on how much you owe.
  • Come up with a payment plan. Finally, with your strict budget in place, make sure you come up with a payment plan. How much can you afford to pay each month? Aim to pay more than the minimum. Chart a timeline, complete with goals and milestones along the way.

Debt is a part of being an active consumer, so it’s neither necessary nor advisable to avoid all forms of debt entirely. To be financially successful, you instead need to focus on avoiding the accumulation of bad debts. More importantly, stay in control of the debt you do acquire. As long as you’re aware of the benefits, consequences, and risks of all your financial transactions, you can avoid becoming a victim, and limit the possibility that your debt will take over your life.

I'm Max and I love helping businesses we work with to expand their businesses online. I help with invoicing, time tracking and overall business needs for business owners. If you need help contact me today.

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