In this MoneyTalk, we will talk about key strategies for Becoming Debt Free.
Do you have financial debt? Do you constantly worry about how to pay off your debt? Does having debt stress you out and make you feel anxious?
For many folks, debt is a significant source of concern as they are constantly worried about how to pay off the debt. Along with paying the interest charges and fees, the feeling of not being able to get out of the vicious cycle of debt can lead to a significant mental burden. Most people think that getting out of debt is impossible, but it’s not.
Let’s first understand why people have Debt. A debt is any type of loan that a person takes to address a need. Now most of us are not born rich. We have to work hard to earn money which we then use to meet our living expenses. If our expenses are lower than our income, then we are able to save money which can then be used for making investments. However, in life, to address certain situations and events, we may need huge sums of money. Most of us may not have that much money saved up or invested, and we then have no other option but to take loans such as credit card loans, student loans, car loans, home loans or even business loans.
In most of these loan arrangements, your first many payments are geared towards paying off the interest fees and then once the interest is paid off, the payments towards the principal commence.
As one starts to take on loans, the required monthly minimum payments keep taking up an extra share of your monthly earnings. The more loans you have, the higher monthly payments you will have to make. If you miss any of your monthly payments, you will not only be charged a fee as a penalty, but your interest rate may also go up leading to higher monthly payments. And, God forbid, if you ever need to take a long-term break from work due to a health issue or if you get laid off from work, your income will be severely impacted which in turn will jeopardize your loan payments.
To be blunt, this is called Debt entrapment which is a form of financial slavery. It’s when you’re so deep in debt that it feels impossible ever to get out. You make minimum payments on your debts month after month, but the balances never seem to go down. Meanwhile, the interest keeps piling up, and you can barely keep up with your day-to-day expenses, let alone save any money for the future. It’s a vicious cycle that can quickly spiral out of control.
If you’re struggling with debt, you’re not alone. It’s a problem that affects millions of Americans. In fact, according to a report from the Federal Reserve, more than 40% of American adults say they cannot cover an unexpected $400 expense without borrowing money or using a credit card or selling something.
But there is hope. You can get out of debt. It might take some time and effort, but it’s possible to achieve freedom from debt. Let’s discuss a few ways you can improve your situation.
1. Analyze your Finances
Many of us have scattered finances as we have multiple credit cards, bank accounts and loan accounts. Since these accounts are with different financial institutions, it becomes very difficult to understand how much money one really has. It is very important to have a consolidated view of all your financial accounts so that you can have a clear understanding of your money and personal finances. We recommend that you use MoneyPatrol to link all your financial accounts to get a consolidated view of all your accounts. This view will help you see your total income, expenses, and debts across the various financial institutions you have relationships with. Additionally, in this exercise, along with your total debt, you can identify your total loan payments, interest fees and interest rates.
2. Identify Your Essential and Non-Essential Expenses
Once you have analyzed your finances, identify the expenses you have incurred over the last few months. You should then categorize these expenses across categories such as Rent or Mortgage Payments, Loan Payments, Bills, Food and Groceries, Clothing, Shoes, Shopping, Travel, Medical and such. Once you have your expenses categorized, you should start identifying your essential and non-essential expenses. This means, figuring out if a particular purchase was essential or was it just a splurge. For example, the expense related to traveling back and forth to work is an essential expense. But, going on a travel trip for fun can be considered a non-essential expense. Similarly, spending on food and groceries is an essential expense. However, if you are purchasing alcohol and cigarettes, then these are definitely non-essential expenses.
3. Improve Savings Rate
Once you have identified your essential and non-essential expenses, do the math on how much you have spent on your non-essential expenses. How much was the share of these non-essential expenses from your income? Over the years, how much does this spending add up to? Now, if you were to not spend on these non-essential things, would you actually save this money and be then able to use these savings to build an emergency fund or even apply these savings towards your debt payments? Not just going over the numbers, but actually having the discipline and dedication to apply rigor and exercise control and not spending money on non-essential expenses will be the key for you to achieve freedom from your debts and this activity is absolutely essential if you want to get out of your pay-day to pay-day cycle.
4. Consolidate your Debts
Once you have started working on curbing your non-essential expenses and improving savings, the next step should be to consolidate your debts. If you have multiple credit cards, you most likely have different interest rates and payment schedules on these loans. In our busy lives, it becomes difficult to manage multiple credit cards and it’s easy to miss a payment, which along with having to pay late payment fees, also racks up the interest rates. You should consider consolidating all your credit card loans into one single loan. There are many debt consolidation services which can bring all your credit card loans under one umbrella. They will offer you a better interest rate, waive your loan transfer fees and work with you on a proper loan payment plan. Some of these service providers will also offer you cash rewards or interest rate discounts to transfer your loans to them. Consolidating your debts will help you immensely in creating a structured loan repayment plan, will save huge amounts of money, and will help you become debt-free faster.
5. Refinance Your Loans
Refinancing your long-term loans such as Student loans, Car loans and Home loans, will allow you to save huge amounts of money. Refinancing can get you lower interest rates and reduce your monthly payments. Refinancing loans is a relatively straightforward process and all you would need is to run your latest credit score and provide your latest bank statements to verify stable income. You can even use MoneyPatrol to check your latest credit score, and see if your score has improved over time. Additionally, if you have been making monthly loan payments diligently and have not missed any loan payments, then most likely your credit score has improved from what it was when you first got this loan. Even if your credit score has not improved, you can work towards improving your score so that you can apply for refinancing in a few months. Refinancing is an option you should seriously consider to save money and pay off your debts sooner than your original loan repayment plan.
Let’s Summarize what we have discussed in this MoneyTalk.
Debts and loans are unavoidable, especially if you are just starting out in life or have had major life events. Debts can add tremendous mental pressure as debt entrapment leads one to be in a vicious cycle of loan repayments and increasing interest rates. To become debt-free, we should
1. Analyze Personal Finances
2. Identify Essential and Non-Essential Expenses
3. Improve Savings Rate
4. Consolidate Debts, and
5. Explore Refinancing Loans
Paying off debt and staying debt free is crucial if you want to lead a peaceful and stress-free life. Eliminating debt can feel as if a big burden has been lifted from your shoulders. You’ll sleep better and you may devote more energy to your career, family, friends, and hobbies now that your mind is no longer occupied by the worry about debt.