By Karly Kolaja 2015-01-06 02:19:44
Recognize the dangers and distress of debt and find financial freedom. HAVE YOU BEGUN CHARGING ITEMS YOU ONCE PAID FOR IN CASH? Do you purchase items on a credit card and then hide the bills from your spouse? Are you finding yourself applying for new lines of credit after maxing out previous cards? While there are a handful of legitimate reasons why any of the above actions might be acceptable in the short term, these signs also indicate you could be in serious financial trouble. According to the Federal Reserve Bank of New York, overall consumer debt in the United States currently rests around $11.63 trillion—more than the combined projected revenue and expenditures of the 2015 federal budget, with about 4 trillion dollars to spare. On top of that, several financial organizations estimate that the average U.S. household credit card debt ranges between $7,000 and $15,500. How did we all get here? What’s our risk of staying mired in this situation? And what are we going to do about it? Sliding Down a Slippery Slope Sure, plenty of people carry enormous debt due to student loans. Others accrue debt in the aftermath of a job loss. Many simply live beyond their means due to the relative ease of obtaining bank and store charge cards. But, “In part, it’s probably because so many believe that carrying debt is just a fact of life,” says David Bakke, writer and contributor at the personal finance website Money Crashers. “And they think that paying interest is a necessary evil.” Accruing high debt can cause very real damage—once the debt becomes unmanageable, it takes its toll on short- and long-term household finances, your lifestyle and even your health. “Several years back, I racked up about $25,000 worth of personal debt,” says Bakke. “Most of my credit cards were closed because of nonpayment, which destroyed my credit score. And, after some bounced checks at my bank, I couldn’t even open a checking account for a while. I spent thousands of dollars in interest and an untold amount of stress getting my debt paid off. Plus, it took years before my credit score began to improve.” Your credit score (see the financial definitions glossary on page 20) is based on your debt repayment history, the total amount you owe different creditors, the length of your credit history, new credit accounts and the types of credit you’ve used—think credit cards, retail accounts, mortgages and personal loans. Overall, the score is designed to reflect your creditworthiness, or the likelihood that you’ll pay your bills on time. When you keep accruing debt, instead of paying it off, banks and lenders will stop allowing you to borrow. Carrying excessive debt can make it difficult to be approved for a mortgage or a car loan—or even a rental lease! “It’s highly likely that you will be denied credit” if your debt is too high, says Gail Cunningham, vice president of public relations for the National Foundation for Credit Counseling. This is a scary position to be in should a crisis strike. “Since none of us has a crystal ball to see what tomorrow holds, we always need to be in a position where we can access credit.” If you are carrying debt, chances are you have some idea of how you got there. Even if you’re unwilling to admit the scope of the problem, Cunningham argues, it’s probably weighing on you. “When money gets tight, people start having that uncomfortable feeling,” she says. “You may not sleep as well; maybe you’re distracted at work. You’re not as good an employee, parent or spouse, because you’re intuitively worried about the debt.” You likely recognize the predicament you’re in; it’s the solution that may be eluding you. Where people often go wrong, Cunningham notes, is that, instead of addressing problematic behaviors, they try to address it with monetary Band-Aids. “Maybe you sell some items. You generate some money, and you’re able to make it through another month,” she explains. “But then you need to borrow money from friends and family, or you have to resort to taking out nontraditional loans, such as a payday or title loan, because a bank won’t lend you money. And the problem’s still very much there.” At some point, the consequences of debt—including the very real possibilities of bankruptcy, garnished wages and eviction—become unavoidable. The enormity of the predicament finally clicks, and individuals in serious financial trouble must admit that they can no longer make their lifestyle work. Practical and Pragmatic Priorities “The first step is to commit to do something about your debt,” says Bakke. “I finally just got tired of the stress and wasted money—that’s what motivated me.” Once you’ve hit bottom and acknowledged that you’ve dug a financial hole, stop digging. Track your spending for 30 days, and begin budgeting, committing to living within your means (See “Bite the Bullet and Begin to Budget” on page 38). Once you start living on cash, you need to know exactly where your money is going. “You can’t plug the leak until you know where the leak is,” says Cunningham. “You can’t know where the leak is until you track your spending.” Everyone in the home who is spending shared household income must participate in this tracking process. “If I ask most people what their house and car payments are, they tell me,” notes Cunningham. “When I ask them how much they spend each month eating out, I get a deer-in-the-headlights look. It’s the little expenditures that add up to be big money.” After your family has completed 30 days of financial tracking, come together and review the results. Then you can begin to plan a budget that will curb spending and ultimately help you to reduce your debt. Start by identifying your monthly necessities, such as food, shelter, clothing, health care and transportation. Once you’ve determined what you absolutely need, Bakke suggests getting rid of services you don’t need, as well as rethinking unnecessary “wants.” If all family members have cell phones, do you need to be paying for a home telephone line? Cancel it. Can you trim down the data plan on your smartphone, let go of your satellite or cable TV package or modify your Internet plan? Do it. Is your current wardrobe sufficient? Forgo those cute new shoes. Do personal electronics—TV, computer, phone—work just fine? Forget about upgrading. Be prepared to have an honest family discussion about priorities and compromises. “Allowing everyone [in your family] to have their say will likely result in a greater buy-in and success,” explains Cunningham. “I always recommend cutting back rather than cutting out. Going cold turkey is going to adjust behavior too drastically and cause people to just give up on the plan.” Take the next few weeks to perfect your budget. Make adjustments here and there until you’ve found a way to gain a monthly surplus—your goal is to have extra money at the end of each month. Once you do, you can create a pay-down plan. Chip, Chip, Chip Choosing which debts to pay first can be a little tricky. Paying off those with higher interest rates can save on total interest accrued, but choosing to tackle smaller debts, or those with lower interest rates, can lead to a greater psychological reward. Regardless, Cunningham advises you “make your minimum monthly payment on everything.” After that, she recommends paying off the smaller debts first. “A lot of folks respond better to having a sense of accomplishment from having paid off a small debt and then moving up to the largest one,” she notes. This strategy sometimes is referred to as the snowball method; it advocates listing your debts in order of smallest to largest by amount owed, ignoring the interest rates, and paying them off in that order. Once you’ve paid off the smallest, you can take the money you were putting toward that debt and tackle the next on your list. Ultimately, though, you need to choose the budget that works best for your situation. When it comes down to the nitty-gritty of debt payoff, there are a few budgeting strategies you can apply. For day-to-day items, such as groceries, gas and cleaning supplies, R. Joseph Ritter, Jr., a certified financial planner at Zacchaeus Financial Counseling, suggests using the envelope system. Using your financial tracking details, put a set amount of “operating” cash into designated envelopes at the beginning of the month or when you get your paycheck. When you go to buy that new bottle of mouthwash or fill up at the gas station, the funds must be paid from that particular envelope. “When the cash is gone, you stop spending in that budget category until the next time you replenish the envelopes,” says Ritter. Of course, when you’re calculating your envelope totals, make sure you take your actual spending into account—you don’t want to run out of gas on the way to work or have to sacrifice milk in favor of eggs. Give yourself a little cushion, and if you have money left over, use it toward paying off your debt. Remember, “You don’t have to wait for [the] due date to send in [bill] payments,” says Tana Gildea, author of The Graduate’s Guide to Money. “If you accumulate $50 in your envelope [at the end of the designated period], deposit it to your account and go online and make a payment” right away. LOANS YOU SHOULD ALWAYS AVOID In certain circumstances, taking out a loan is inevitable—very, very few people can afford to pay for a home, auto or college education in cash. But, there are certain types of credit that you should avoid at all costs in order to stay financially healthy for the long term. Advance Fee Loans An advance fee loan requires that you pay money upfront before you can receive your allowance. Typically, a lender will either take your money and run or charge you very high interest rates. Payday Loans In order to get a payday loan, you write a check to the lender for the amount you want to borrow, plus a percentage of the total amount. The lender doesn’t cash this check right away. On your next payday, you either repay the loan and get your check back, or the lender keeps your check and increases the fee. Fees upsurge with each unpaid week. Refund Anticipation Loans Refund Anticipation Loans are high-interest loans typically offered by tax accountants. Instead of waiting for your government refund at tax time, your tax preparer offers you money upfront. Expensive fees and interest apply, so in the end, your refund will be smaller. Rent-to-Own Loans Some stores offer rent-to-own loans on certain electronics, appliances and furniture. If you can’t make the payments, however, the store will repossess the merchandise, even if you’ve already paid more than what it’s currently worth. Pawnshop Loans Pawnshops can loan you money after accepting personal property as collateral. They charge high interest rates and, if the loan isn’t repaid in a designated period, the shop can keep and sell your property. Overdraft Loans An overdraft loan allows you to draw money from your checking account, even if you have insufficient funds. Small overdraft fees of $30 or $35 apply, however, and these can add up to a significant cost over time. Moderation Is Motivation Maintaining a viable lifestyle while paying off debt is a bit of a balancing act—it’s one of the reasons folks are scared to start facing their finances and sticking to a budget. The thought of cutting costs can be overwhelming, especially when you’ve become accustomed to charging the things you want, and sometimes, need. If you cut down to the point of making your life miserable, you’ll eventually give up and go back to racking up debt. Luckily, many ways to reduce monthly bills involve minimal to modest sacrifices. (Think cooking in instead of going out to eat.) Most lifestyle changes, Bakke points out, simply call for a change in habits or perspective. “Have friends and family over for a game night or trivia,” he says. “Renting DVDs from Redbox, which costs about a buck per day, is a lot less expensive than the movie theater, as well.” Involving your loved ones in your cost-cutting strategies builds more than happy memories—it helps you stay on track and motivated. “Challenge friends to come up with free and fun things to do instead of routine and expensive things,” advises Gildea. When you partner with friends and loved ones, you encourage and support one another. Remember, small and medium sacrifices don’t have to last forever. “Folks who want to get out of credit card debt but are afraid of changing their lifestyle need to understand one thing: Whatever changes you need to make aren’t permanent,” says Bakke. “You only have to cut back until your debts are gone. Once that happens, you might be stunned at how much money you have left in your checking account each month.” One thing to keep in mind, however, is saving—not for future debt repayment, but for emergencies. Try to put a small amount money aside every month, even if it’s just $15 or $25. Just as with paying off your debt, every little bit adds up. Generally, Lori Atwood of Fearless Finance notes, you’ll want to get to at least $2,000 for a family of four—although this number is dependent on the cost of living in your area plus your family’s specific needs, so be honest with yourself. This emergency savings fund won’t cover basic expenses if you lose your job, but it will help you to pay auto repairs, home fixes, root canals and the like, without being tempted to pull out the charge card. (For more savings strategies, see “Savings Grace,” on page 26.) When the Sirens Sweetly Sing Breaking bad habits and staying on track with your repayment plan can be overwhelming, and temptation always beckons. Reduce the risk of a slip by making your charge cards difficult to access. Too anxious about potential emergencies to cut up the cards and close the accounts? Put them in a lock box, keep them on a difficult-to-reach shelf in your closet or store them in a safety deposit box. Regardless, you need to put them on ice—maybe even literally. “Some people put their credit cards in a bowl of water and put it in the freezer,” cites Cunningham. “That keeps them from making impulse purchases, puts a little distance between them and consumer goods and gives them the ability to think things through.” It also helps to avoid temptation altogether. Identify typical spending cravings and come up with a plan to avoid “red light” enticements. For example, if you’re an avid online shopper, stop visiting consumer websites. Unsubscribe from a store’s e-mail notifications of special deals and sales. Need more help with self-restraint? There are web browser plugins, like StayFocusd (no, that’s not a typo) that you can use to block tempting sites, subdomains or specific pages altogether. If the Internet’s not your only access point, go further. Delete QVC from your remote control’s tuner. Put a block on receiving catalogs in the mail. Avoid malls entirely; ask someone else to pick up a necessary item for you. You know the compelling lure of your personal spending temptations, be they food, gadgets, vacations, clothes, experiences or others. It’s up to you to subdue them. Rewards and Relief Paying off your debt doesn’t have to be a completely joyless slog. Ritter recommends building certain treats into your budget. Whether it’s a nice dinner out or a weekend getaway, aim for one splurge roughly every six months. “This is crucial when your plan to get out of debt [will take] two years or more,” he says. “While you might be fired up now about getting out of debt, about six to 12 months into the process, you will start to feel burnt out and like it’s drudgery.” Ritter recommends that you spend no more than $250 on each of your indulgences. Less is even better, but you do want these to be meaningful experiences. Still, there’s no denying that the process of paying off debt is long, challenging and slow. Don’t let this reality be a source of procrastination that only makes things worse. Once you commit to taking action and develop a timeline for paying off debt, it should be manageable, even if you do have the occasional lapse. “Expect that you will slip up, over-spend or that life will pop up and get in the way. It’s OK,” says Gildea. “Take a deep breath, regroup and refocus. Start again and learn from the mistake or misstep. Keep at it, and eventually you will make that last debt payment.” Karly Kolaja is a freelance writer based in Connecticut. She can be reached at firstname.lastname@example.org. Photography by iStock/jiunlimited.com.
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