A combination of rising living costs, high inflation, unexpected financial emergencies, and reliance on credit has created a perfect storm for personal debt. In fact, American household debt increased from 16.9 trillion in 2022 to 17.05 trillion in the first quarter of 2023 and rose again to 17.69 trillion at the beginning of 2024. It might seem hopeless, but eradicating debt is achievable with the right strategies. In the following article, we discuss common mistakes to avoid when climbing your way out of debt.
Not Changing Spending Habits
One of the biggest mistakes people make when trying to get out of debt is continuing to spend beyond their means. If you create a budget, track expenses, identify non-essential spending, and cut back wherever possible, you’ll have more money to put towards tackling debt. This disciplined approach will also help you build smart spending habits to keep you from falling back into debt.
Not Keeping Credit Cards Open After Paying Them Off
While it may seem logical to close credit cards once they’re paid off, doing so can actually hurt your credit score. Credit utilization, the ratio of your credit card balances to your credit limit, is a significant factor in your credit score. Closing a credit card reduces your available credit, which can increase your credit utilization rate and negatively impact your score. Instead, keep the account open, use it sparingly, and pay it off in full each month.
Not Funding an Emergency Account
Neglecting to build an emergency fund is a major mistake. Without a financial cushion, any unexpected expense can throw you back into debt. The first step to building an emergency fund is to save $1,000. Once that goal is met, work toward a goal of saving at least three to six months’ worth of living expenses in a high-yield savings account. This fund will provide a safety net, allowing you to handle emergencies without relying on credit cards or loans.
Effective Debt Repayment Strategies
Avoiding mistakes when paying off debt is just one piece of the puzzle. Understanding the best methods to pay off debt is another significant piece of the puzzle to your payoff journey. Here are two of the most common and effective strategies:
Debt Snowball Method
The debt snowball method involves paying off your smallest debt first while making minimum payments on the rest. Once the smallest debt is paid off, you move on to the next smallest, and so on. This approach can provide quick wins and build momentum, keeping you motivated as you see you check off each debt.
Debt Avalanche Method
The debt avalanche method focuses on paying off debts with the highest interest rates first. By tackling high-interest debt, you save money on interest over time, which can lead to quicker debt elimination. This method might not provide the immediate psychological boost of the debt snowball, but it’s more cost-effective in the long run.
Refinance or Consolidate Debt
Another option to pay off debt is to refinance or consolidate your debt. This can lower your interest rates and simplify your payments. Look for options like balance transfer credit cards, personal loans, or home equity loans with lower interest rates. Just make sure to read the fine print and understand the terms before committing.
Set Aside Raises and Bonuses for Debt
Allocating raises, bonuses, and windfalls to debt repayment can make a significant dent in your balances and reduce the time it takes to become debt-free. It’s a powerful way to accelerate your debt repayment journey without affecting your everyday budget.
Boost Income and Reduce Expenditures
Boosting your income and cutting back on expenses are two sides of the same coin in your debt repayment strategy. Consider taking on a side hustle, freelance work, or part-time job to generate additional income. At the same time, look for ways to decrease money going out, such as negotiating bills, canceling unused subscriptions, and getting comfortable with a more frugal lifestyle.
Finally, accelerate your debt payment by paying more than the minimum monthly payments whenever possible. Throw any excess cash at your debt, no matter how small the amount. It may seem futile in the beginning, but the more you can do this, the faster you’ll dig your way out of debt.
