Here's a look at 10 ways you could be digging yourself a bigger debt hole, and expert-approved hacks to achieve financial freedom.
In theory, staying out of debt seems like a straightforward process: By not spending more than you can afford, you’ll be debt-free. However, as millions of Americans with debt can attest, it can be more complicated than that. Common attitudes toward money-management and spending can make it easy to slide into debt.
“Our financial mentality is to buy now [and] pay later,” says Leslie Tayne, attorney and founder of Tayne Law Group. The convenience of financing, expectations of family and misguided repayment attempts can all conspire to keep households in debt.
With that in mind, here’s a look at 10 ways you could be digging yourself a bigger debt hole, and expert-approved hacks to achieve financial freedom.
Using savings to pay off debt. While it may seem like a smart idea to take money from low-earning savings accounts and pay off high-interest debt, it’s a strategy that can backfire, says Kelsa Dickey, a financial coach with money management firm Fiscal Fitness Phoenix in Arizona. “What they are really doing is making it harder for themselves,” she says.
Emptying a savings account to pay off debt leaves households without an emergency fund. Then, you may turn to credit cards or have to take out a loan should your car break down or a large medical bill arrive. And going into debt for every unexpected expense can be disheartening. Avoid this mistake by keeping adequate financial reserves to pay for emergency expenses.
Splitting cash among bills. Dickey says she often sees people use a divide and conquer method of debt repayment. A person who has, for instance, an extra $500 may send $100 to five creditors. It seems like a smart strategy to pay down all debts equally, but the reality is that small payments don’t make much of an impact on the balance.
“You feel like you’re never getting ahead,” Dickey says. Without seeing progress, you may be less likely to try to tackle your debt problem. A better strategy would be to concentrate all extra money on one debt at a time to quickly see results and stay motivated.
Signing up for subscription plans. Subscription services are another unexpected contributor to debt, according to Mike Sullivan, a personal finance consultant with Take Charge America, a nonprofit credit counseling agency. People assume they don’t have much impact because the monthly cost is often low, he says.
Streaming movies from Netflix or listening to music through SiriusXM for $10.99 a month may not seem like a high price to pay. However, if you subscribe to multiple services, the cost can add up and mean less money is available for savings, debt repayment or other goals. That’s why it’s key to be intentional about your subscriptions and only sign up for those you know you’ll use regularly.
Financing purchases. Nowadays, financing is available for practically any purchase. For example, the online payment service PayPal lets its users take six months to pay off anything costing $99 or more.
“You’re borrowing for almost every aspect of your life,” Tayne says. Not only does financing have the potential to cost consumers extra money in interest charges, but it also sets them up to make purchases they wouldn’t otherwise consider. For example, people may think twice about spending $1,000 for a phone, but it doesn’t seem like a big deal when paid off in full over a two-year period.
Zero interest financing plans can be particularly appealing, but they may get people into trouble, Tayne says. “They think ‘I don’t have to pay that off for 18 months’ and then in the 16th or 17th month, something unexpected comes up,” she explains. Then, when the balance isn’t paid off on time, the account may take on all the compounded interest from the previous 18 months. Rather than taking advantage of financing offers for retail products, save up and pay with cash to avoid running up your debt.
Taking out long-term auto loans. The standard term for auto loans used to be 36 months, Sullivan says. Now, many financial institutions will let you finance a car for 84 months, which is equal to seven years. “My experience with consumers is that very few can keep a car working for 84 months,” Sullivan says. “They are underwater the whole time.” That means consumers owe more than the car is worth and can’t sell it to get out from underneath the payment. When the vehicle is replaced, they may have to roll their balance into a new loan and further increase their debt.
If you must finance a car, opt for an affordable model and finance it for as short a term as possible.
Playing the rewards game. Many credit cards offer lucrative rewards such as cash back offers or points that can be used for travel or merchandise. In order to maximize rewards, people may be tempted to charge purchases they wouldn’t already make.
“I’m not anti-credit card, [but] it’s a slippery slope,” Dickey says. It doesn’t take long for extra purchases to create a balance that can’t be paid off every month. Then, interest charges may negate the value of any rewards earned. To avoid this scenario, it’s best to limit discretionary spending on credit cards and only charge recurring bills or other expenses that must be paid.
Buying based on others’ expectations. One of the reasons people go into debt is to keep those around them happy. “We spend not so much for ourselves, but for other people,” Sullivan says. “No one wants to disappoint their spouse at vacation time or the kids at Christmastime.”
Emotions can be difficult to navigate, and that’s part of what makes this debt trap so difficult to avoid. Staying aware of your motivations before spending can help ensure purchases are made for the right reason. More important may be open communication with family members and friends to keep their expectations reasonable.
Failing to learn about financial planning. Many people find themselves trapped in debt because they don’t understand financial basics. They may not realize how much interest is charged on payday loans or the total cost of buying something through a rent-to-own agreement. “These industries exist because people aren’t very sophisticated,” Sullivan says.
Fortunately, this is an easy problem to correct. Financial books, websites and apps, as well as financial literary courses, are readily available to teach basics of money management.
Ignoring your options. It’s easy to get caught up in perceived social norms, but finance professionals say people need to remember almost everything you buy is optional.
You are not obligated to finance a degree from an expensive four-year school or drive a new car, Tayne says. “Those are choices.” Community colleges and used cars may get you the same results at a fraction of the price. Rather than spending $100 a month on phone service, sign up for a low-cost carrier like Cricket Wireless or MetroPCS and pay less than half that amount. Scrutinize all your expenses to determine whether cheaper options exist. Paying less for these services will then free up money in your budget to keep you out of debt.
Assuming being debt-strapped is a way of life. Perhaps nothing traps people in debt as much as the mindset that they will always be in debt. “People don’t challenge what they’ve always done,” Dickey says. For many, having a car loan, credit card balance and mortgage is to be expected.
“The trick is to not buy everything someone tells you [that] you can afford,” Sullivan says. Saying no to unnecessary purchases is a critical skill and essential to sticking to your budget and getting out of debt for good.