Managing Debt

How to Stay Debt-Free

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If there’s anything that’s as important as getting out of debt, it’s staying out of debt. And the first step toward staying out of debt is to fully understand your current financial situation, and establish some goals on how you want to spend your money.

It might sound like an overwhelming task, but it helps to take small steps. Start by reflecting on your values and what is truly important to you. Then, using this information, write down the goals you would like to accomplish over the next five to 10 years.

Initially, you should just brainstorm, and write your goals as they come to mind; don’t analyze the practicality of each goal. Later, review your list of goals and prioritize those you’d really like to accomplish. This gives you a basis from which to make decisions on where to spend money.

But to realize these goals, you have to put what you have in writing into action.

Keep From Getting In Too Deep

People frequently run into trouble with debt because they don’t understand their current situation. Evaluate your current cash flow by identifying your expenses and comparing them to your current income. Then see if — and where — you’re coming up short, and whether you are on track to accomplish your goals. Break it down into these steps:

1. Look through your checking account and credit card statements for the past year to determine where you have actually spent money. Be sure to include bills that are paid annually and expenses that are generally paid in cash. It can be helpful to categorize expenses as discretionary or non-discretionary.

2. Compare your expenses to your income and determine how much is left for saving and investing.

3. Evaluate how you are spending your money and how it aligns with your goals. Does your spending plan support or sabotage your plans? Rework your spending plan to better support your goals and values. Monitor your cash flow on a monthly basis to make sure you stay on track.

Generally, a great way to avoid going into debt is to live below your means. Make the tough decisions to keep your expenses below what you earn so you can deal with unforeseen problems when they arise. It is common for us to continually increase our expenses and standard of living as our income increases.

It’s easy to get caught up in a lifestyle that we can’t afford should we lose our job or run into other financial difficulties. And we can get trapped in a lifestyle and a job we may not enjoy. Living below your income provides you with the flexibility and security to adapt to a changing environment. Staying out of debt is generally under our control based on the decisions we make.

Create a Safety Net

There are a few key steps everyone should take to avoid going into debt. The first is to create and maintain an emergency fund of at least four months of expenses. This money should be kept in a savings, checking or money market account that is fully liquid.  The second is to save at least 10% of your gross income. Think of this as a bill that must be paid. Initially, this may be used to build up an emergency fund and later may be used to build your retirement fund. By saving at least 10% of your income you always have a buffer to keep you out of debt should financial emergencies arise.

Finally, do not carry a balance on any credit cards or personal loans. If you can’t pay off your credit cards in full at the end of every month, don’t use them. Avoid financing personal items such as furniture, clothing and electronics. Instead, wait and save up the money to pay cash for the personal items that you want.

The Good Side of Debt

There are some instances when debt can be a useful tool in achieving your financial goals, such as using a mortgage to purchase a house. However, when purchasing a home, it’s important to make sure that you can easily afford the mortgage payment and still have money to save and meet your other financial obligations.

Similarly, so is the reasonable use of student loans. A student loan can be a good investment toward getting a higher paying job once you graduate. Be sure to use student loans sparingly, and for a degree that will lead to a worthwhile career. As a rule of thumb, college loans should not exceed more than one year’s salary in your career of choice.

Some ideas for minimizing student loans include living at home, attending a community college for the first few years, working a part-time job and applying for scholarships. Parents should never sacrifice their retirement savings to put a child through college.

Image: iStockphoto

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