Debt freedom is key on the journey to financial independence. No matter when you’re hoping to achieve financial independence, we all ultimately want to be able to stop answering to a boss and live life on our terms. Here are five roadblocks that could be in your way on the path to living a debt-free life.
Thinking You Don’t Need a Budget
A budget doesn’t have to shackle you to a life of deprivation. Instead, it can help put rules in place so that you can spend lavishly on what you value and nix the things you deem unimportant to your life. But living a life without any sort of financial structure is a recipe for getting into and staying in debt.
The easiest way to start is just by running your cash flow for the month.
(How much is coming in) – (how much is going out) = what you have left to spend
If your remainder is negative, then you have to evaluate the outflow and see where you can make cuts or focus on increasing the cash coming in.
Carrying a Balance on Your Credit Card
There are two common reasons people end up carrying a balance on a credit card. The first is the obvious one of overspending and not having the funds to pay off the card. It’s a common way to sink into the debt hole, especially since credit card interest rates are usually around 15 to 25 percent APR. As soon as you hit a month where you can’t pay off your credit card in full, then it’s time to make a debt repayment plan.
The other is a bit more nefarious. There is a terrible rumor floating around that it’s better for your credit score for you to carry a balance month-to-month. This is FALSE! It comes from a twisted misunderstanding between having a balance vs. carrying a balance.
Let’s break it down.
Utilization makes up 30 percent of your credit score. Utilization is just a fancy word for how much of your available credit you use. For example, if you have a $1,000 line of credit and spend $200 of it, then you’re 20 percent utilized. Generally, you want to keep your utilization below 30 percent because that looks responsible. Think of it as if they’re trying to tempt you to spend more and you’re proving that isn’t going to work. The easiest way to behave well is to use a little bit of your credit limit and then each time the bill comes in, you pay it off on time and in full.
Here’s the rub: if you don’t use any of your available credit limit and it’s always at zero percent, then the credit score companies can’t actually determine if you’re a responsible borrower or not. Using a little bit of the available credit and then always paying it off on time and in full indicates a responsible borrower. Having access, but not using it doesn’t offer them any information about your behavior as a borrower.
At some point, people confused the difference between having a balance (showing you made some purchases on your monthly credit card statement) and carrying a balance (not paying off your bill in full).
Carrying a balance means you aren’t paying off your full bill so each month you’re carrying over debt and having to pay interest. That’s a waste of your money and it’s not necessary in order to build a strong credit score. Always, always pay off your credit card bill on time and in full.
Letting Other People Spend Your Money
“Keeping up with the Joneses” isn’t the only way in which you let other people influence how you spend your money. It’s incredibly easy to allow other people’s life events – weddings, baby showers, birthdays – impact your wallet in a way you simply can’t afford. You get trapped in that awkward place of not wanting to disappoint a loved one or being seen as less than, which then results in you going on a $3,000 bachelorette party or hosting a bridal shower that is getting financed on your credit card. (I really wish I was making that up, but I know people each one of those things happened to.)
Part of #adulting is learning how to politely decline, even when you want to go but know you can’t afford to participate.
Fail to Make a Debt Repayment Plan
Already being in debt may result in you feeling like, “meh, what’s a little bit more?”. It’s so easy to get trapped in that debt cycle, but having a specific, actionable repayment plan can help you fight your way out. Here are two common options to consider:
- Debt Snowball: You write down your debts from the smallest to the largest balances. Keep paying all your minimums due, but any extra money goes towards the smallest balance debt. Once that’s paid off you use all the money you were putting towards that debt and start applying it to the second smallest debt. Paying the small balance off relatively quickly gives you a nice psychological boost and you’re motivated to keep pushing towards debt freedom.
- Debt Avalanche: Instead of focusing from smallest balance to largest, you write down the debts by the largest interest rate to smallest. Then replicate a similar process as snowball, but this time you’re trying to pay off in order of highest to lowest interest rates instead of lowest to highest debts. It usually takes longer, but you save more money by attacking your highest interest rate debts first.
Spending More Than You Earn
This is extremely basic and border lining on cliché advice, but it’s ultimately the crux of living a debt free life. You have to adjust lifestyle in order to live below your means. This can happen in one of two ways:
- Spend less
- Earn more
Or a combination of the two. Continuing to keep spending more than you earn means a life constantly battling the debt dragon, and no one has time for that.
The views and opinions expressed in this video are those of the author and do not necessarily reflect the opinion or view of Intuit Inc, Mint or any affiliated organization. This blog post does not constitute, and should not be considered a substitute for legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.