Debt is a double-edged sword. It can be useful when you’re investing for the future, but eventually you’ll need to pay off your debt to build your assets. Failure to do so (for whatever reason) results in a vicious cycle of debt that is difficult or even impossible to escape.
For many consumers, borrowing is a way of life. Mortgages and student loans, often considered “good debt,” take up a significant portion of your monthly income. It’s easy to add credit card debt and a new car loan every few years. Payday loans and other toxic loans are guaranteed to lead to a cycle of debt.
What Is a Debt Cycle?
The debt cycle is continuous borrowing that leads to more debt, more spending, and eventually default.1 If you spend more than you take in, you go into debt. At some point, interest costs will become a significant monthly expense and your debt will grow even faster. You may be able to take out a loan to pay off an existing loan or meet a required minimum payment.
Sometimes it makes sense to take out a new loan to pay off existing debt. Debt consolidation can help you lower your interest payments and simplify your finances.2 But that doesn’t mean you’ll need a loan to cover living expenses (or to finance your current consumption instead of investing in the future through education and real estate) Start when. It’s getting harder and harder. Frustrating.
How to Get Out of a Debt Trap
The first step to getting out of the debt cycle trap is admitting that you have too much debt. No need to judge. The past is just the past. Look at the situation realistically and act.
Even if you pay off all of your debt each month, you will still be in debt and stuck in your current lifestyle. If you’re in debt, it’s impossible to quit your job, change careers, retire one day, or move across the country without a job for your family. Once you understand what you want to get out of debt, you can start working on a solution.
Understand Your Finances
You need to know exactly where you stand. How much income does it bring in each month and where does all that money go? It is very important to keep track of all your expenses. So do everything you can to make it happen. You only need to do this for a month or two to get good information. Here are some tips for managing expenses:
- Use your credit or debit card to get an electronic record of all your transactions.
- Bring a notebook and pen.
- Keep (or create) receipts for all your expenses.
- Create an electronic list as a text document or spreadsheet.
Especially if you pay your bills online, you should review your bank statements and credit card bills for several months to make sure you include expenses that don’t occur every 30 days, such as quarterly or annual payments. Balance your accounts at least monthly to avoid surprises.
Create a Spending Plan
Now that you know how much you can spend (your income) and how much you can spend, you can create a budget that works for your life. Start with all your real “needs” like housing and food. Then look at your other expenses and see what works for you. Ideally, you’ll budget for future goals and pay yourself off first, but paying off debt may be a higher priority. Unfortunately, you may have to make some unfortunate changes at this point. Shop for groceries, buy cable, get a cheap cell phone plan, commute by bike, and more. Find ways to spend it. This is the first step to living below your means.
Put Away the Credit Cards
Credit cards aren’t necessarily a bad thing (in fact, they’re pretty good if you pay them off every month), but it’s all too easy to get into debt. Most cards have high interest rates, so you’ll end up paying more for everything you buy, and paying the minimum can be a problem. Do whatever it takes to stop using it. Cut them into small pieces, put them in a bowl of water and put them in the freezer, or whatever you want. If you like the convenience (and automatic tracking) of your plastic spending, use a debit card linked to your checking account or a prepaid debit card that doesn’t cover debt.
Change Your Habits Little by Little
It’s nice to have a “big win,” like getting your car discounted or canceling your expensive cable service. But even small changes matter. You can go out to lunch with your coworkers a few times a week, dine out on the weekends, and spend a lot of money attending concerts and ball games. This isn’t a bad expense, but going into debt to do it can hurt your budget. If you want to get out of debt, you have to gradually change your habits. Start by making coffee at home and taking your lunch to work.
Cut Your Borrowing Costs
It’s risky to take out additional loans, but you may need one last loan. If you have high-interest credit card debt, you may not be able to afford the monthly interest charges even if you pay a large amount. Debt consolidation with the right loan ensures that every dollar is spent on debt reduction. But you have to be disciplined. Once you pay off the debt (or, more specifically, transfer the debt), you can no longer spend money on this card. Credit card transfers are a way to get cheap temporary credit (note that promotional periods end), and online lenders offer competitive interest rates on long-term loans.
