With the ease of applying for loans or credit cards, getting into debt can happen quickly and quickly become accumulative. Not being able to pay off your debt effectively can be an intense struggle that only gets worse over time. There are right and wrong ways to pay off your debt. Doing it the right way will not only get you out of debt faster but also put you in a position use the excess money after the debt is paid and doing something more constructive with it, such as saving or investing.
In this article, we will look at common mistakes made when trying to pay off debt.
Establish a budget before paying a debt
A budget is essential to establish just how much money can be put towards the debt while still having enough money to cover other monthly expenses. Until a proper budget has been made, it is not possible to truly know how much money can be put toward the debt. A common mistake made, with the pressure of creditors, is to pay off more debt than can be afforded, putting the person in a position where they cannot pay their bills. A budget can reveal just how much money can be allocated to each monthly expense.
Putting the debt before a cash reserve
Everyone has sudden expenses that come up through each month such as medical emergencies or essential items breaking down. Many people make the mistake of throwing every extra cent towards paying off a debt. This ends up putting people back into more debt as funds need to be loaned in order to pay these unforeseen expenses. Surplus funds should be saved after paying the amount of debt that was budgeted for that month.
Acquiring multiple debts without addressing the underlying issue
Many people will look to consolidate several smaller debts or loans into one loan in order to get lower interest rates, which is a good idea but not if the real issue is not properly addressed. If the cause of the continual loans and debts is not looked at, the debt will continue over the long-term. The person may need to reconsider spending habits or lifestyle choices – something more in line with their budget. Once a budget has been established and maintained, then consolidating debt into one low-interest rate loan is an excellent idea.
Spreading yourself too thin
In other cases where people have several smaller debts, they tend to want to pay the most urgent debt first. With a payment plan in place, the results can be unfruitful. When dealing with many smaller debts, the best way to approach the problem is by paying the minimum amount on each separate account except the smallest debt that can quickly be paid off in full. Using surplus funds to pay the smallest loan first will help the person to feel like they are making progress and it will require less work overall since there is less debts to deal with.
Using the system the bank wants you to use
For years, the banks have told people to use the credit card to pay their bills and have their income go directly into their home loan. As long as the credit card is paid off in time, your home loan interest rate continues to lower. However, only about 5% of people manage to do this. The majority of people pay the income into their home loan and expenses on their credit card end up spending more than expected and the money thought saved through this process ends up going to their credit card.
This method is only effective if a budget is followed exactly, with room for unexpected expenses. The banks continue to recommend this method because it tends to keep people paying their home loan for longer, even though it seems to work on paper.
If debt is not carefully managed through the use of strict budgets and appropriate debt management, it can easily become too much for many people to cope with. Understanding the limits of your income and the impact it has on your lifestyle can help to ensure that unmanageable debts are not incurred on a regular basis.