Adopt the 8 Basic Principles of Avoiding Bad Debt

From retirees to new college graduates, debt management is probably the number one financial literacy challenge today.  While there are forms of good debt, many financial troubles are in some ways tied to bad debt.  Kids don’t think about it at all, and many parents report debt management as being a long term challenge.  In a culture of immediate gratification and where living beyond your means has become easy, it is important to understand that there are ways to avoid bad debt.

Most of the advice you see on the subject of debt is how to get out of it, rather than how to avoid it and minimize it in the first place. Think about it like gaining weight, where most of us need to avoid accumulating it, rather than look for some magic solution to getting rid of it. As with weight loss, it is easy to fall pretty to solutions that are untested, unrealistic, or simply don’t work.

Thus the simplest strategy for managing bad debt is to avoid it where possible. The first step is learning that all debt is not the same, and all financial instruments like credit cards and home mortgages, have both positive and negative attributes. Here are some key debt principles that will help you survive the financial challenges of today:

1. Differentiate between “good debt” and “bad debt.”  Good debt has long-term strategic implications, like a mortgage on a rental property or a student loan that helps pay for a degree that will increase earning potential. Bad debt would include the coverage of short-term shortfalls, impulse purchases, and pushing your lifestyle up a notch.
2. Adopt a smart strategy for using credit cards.  Credit cards are great when used to minimize the need for carrying cash, and keeping monthly reports on your spending or taking advantage of rewards. Don’t let them lull you into spending beyond your means, and pay the total amount due each month. That way you get the reward points, discounts, or even cash back, but not the debt penalties.
3. Resolve to never pay late, and never miss a payment.  Always budget and commit to pay your bills on time, and in full.  Missing payments or making late payments will cost you penalties, lower your credit score, and lead you to bad debt. To avoid excuses and last minute distractions, use the automatic payment feature available at every bank.
4. Measure and adjust.  You can’t manage what you don’t measure, so write down what you need to spend, and what money you really make.  A realistic spending plan is one of the most important elements to a successful financial plan.  Otherwise your dreams and whims will lead you down the path to bad debt.  Be honest with what you can afford, and include a strategy for eliminating existing debt in the budget.
5. Don’t take on any debt without a clear plan to get out.  Build a plan to get out, with a timeline and a budget, before you commit yourself even to good debt. If you can’t come up with a clear plan to do it with debt, then plan to do without it.  Debts are more about perceived needs and priorities, rather than life or death decisions.
6. Don’t be afraid to ask for help.  If you are about to miss a monthly payment, pick up the phone and explain, before you are tagged as a failure statistic. Be friendly, not adversarial, and offer a reasonable catch-up plan.  Make sure you are talking to someone who actually has the authority and perspective to address your request.
7. Maintain an emergency fund.  Everyone has financial emergencies, no matter how carefully they plan.  These could be personal health problems, unexpected car repairs, or freaks of nature.  Teach your kids that the piggy bank is an emergency fund, so start small, but emergencies get bigger as you get older, so the fund needs to grow over time.
8. Financial literacy is a continuous learning experience.  Use the Internet and daily newspapers to stay informed. The rules for avoiding debt and managing debt change every day, due to legislation and tax changes, the state of the economy, and your own personal situation (student, married, retired).  Ignorance will not get you out of debt.

Contrary to what you read in the papers, or hear from your neighbors, it is possible to avoid bad debt by managing your resources wisely. If you do incur debt, such as a reasonable amount in order to purchase a modest home or complete your education, work to repay it as quickly as possible and free yourself from that long-term burden and risk.

By successfully managing debt, you will better prepare yourself to take on additional financial literacy complexities, and you might find yourself really enjoying life and your family for a long time to come.

To your success!

 

Sharon