Debt is a funny thing. Maybe, a terrible thing. If your debt completely takes you over, then it can definitely be a terrible thing. What we need to keep in mind is that sometimes debt can be good. It can help us buy our next home or our next car. The bad debt? Credit cards and personal loans. I’m sharing 6 common debt causes that result in you swiping your plastic, and how you should avoid those causes, at all costs!
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Before I dive in to common debt causes and how you can avoid them, I want to harp on the difference between good and bad debt.
As I mentioned above, good debt comes in the form of a mortgage loan or an auto loan (although this is debatable, depending on the value of your car). Assuming that both your home and your car are more valuable than what you have outstanding on the loan, then they can be seen as good debt.
Good debt allows you to borrow money to purchase an asset. The idea is that the amount you owe will go down as you pay the loan, but the value of the asset will stay the same or continue increase. This means you are increasing your net worth (the value of your assets less your debts) with each payment.
The other side of this is bad debt. Bad debt comes in the form of credit cards, personal loans, payday loans and any other form of credit that is not tied to an asset. What makes this kind of debt so bad? Well, for one, there is no asset tied to it. That means each payment you make is getting you closer to breakeven, not ahead.
Another thing to keep in mind with bad debt is that it puts you in the negative. There is no asset on the other side of the debt that can help you cancel out the liability. The minute you use your credit card, you are putting yourself in the negative, assuming you can’t pay it off immediately.
Unless you pay your credit cards in full every month, it’s best to avoid using them until you have broken even, in other words, until your balances are paid in full.
Now that you understand the difference between good and bad debt, let’s talk about some of the most common debt causes and how to avoid them.
Common debt causes:
An unplanned or unexpected expense
Let’s assume you have a tight-nit budget in place. You ensure that your income is allocated down to the penny and all of your bills, expenses and spending is accounted for. Great! Now, what happens if your car breaks down? What happens if you need to take a short notice plane trip home to see a family member?
My point? If your budget does not account for unplanned and unexpected expenses…and, let’s be real, why would it…these expenses are not planned for…you may be left with more money going out than coming in. That likely means using debt or tapping into your savings.
9 times out of 10, people will leverage debt because they don’t have a savings. In fact, two thirds of Americans would struggle to cover a $1000 emergency, according to the University of Chicago.
So, how do you plan or prepare for unexpected expenses? Easy, plan for the unplanned. I would suggest you do this by factoring a “Miscellaneous” category into your budget. Each month (or whatever schedule your budget is on), make sure a certain amount of money is designated to this category.
Your “Miscellaneous” category will help ease the financial burden of pesky unplanned or unexpected expenses. If nothing comes up one month, put the money into a savings account just for unexpected expenses. Ideally, it will be smooth sailing for a few months so you can rack up a nice savings.
The ultimate goal would be to save $1,000 just for unexpected expenses. This will be your “short-term” emergency fund. Once you reach this goal, take pride in your efforts. You are now on the other end of the statistic!
Whether you are in a multi-income household, or you just rely on your own income, loss of a job or any other income source could cause you to leverage debt. Going back to your budget, if your current income covers all of your expenses, with little room for saving, it’s obvious that you will be in financial trouble when that income is cut.
Regardless if you were laid off, experienced a decline in business revenue, left work to care for a child, or any other reason, a loss of income can hurt your bottom line. This may force you to use credit to keep yourself afloat until more money comes in.
The best way to protect yourself from a job loss or drastic drop in income is to have an emergency fund. Not the short-term one I referenced above (although that will help). I’m talking about a true emergency fund – ideally three to six months’ worth of living expenses. This is not an easy feat. Building a successful emergency fund takes work, but it will be worth it.
Start by building up your short-term $1,000, then focus on paying off high-interest debt. Once those two items are achieved, start saving for your real emergency fund. The earlier you prepare yourself, the better off you will be if job loss does come around.
Another way to help ensure job loss or loss of income doesn’t lead to racked-up debt, is to live below your means with the income you do make. This means spending significantly less than you earn, in all areas. That way, if a loss of income does come around, you will already be used to living on less income and the adjustment shouldn’t be too strenuous.
Did you know that unpaid medical costs are one of the leading causes of bankruptcy in the United States? Having health insurance does not mean that any and every medical cost will be covered. Of course, it helps ease the burden, but it may not cover the entire bill.
According to Wisebread, “The Kaiser Family Foundation found that three in 10 Americans report that they or a household member have had trouble paying medical bills in the past year — 58 percent of which were affected in a way that had a major impact on their life. More than 60 percent of respondents claim their savings were wiped out. Another 37 percent turned to credit cards.”
Being knowledgeable about what your insurance coverage includes, and the saving for the difference can be a financial life-saver. If your company benefits include an HSA or FSA, take advantage! These accounts are tax-free and can help cover medical expenses not covered by your insurance provider,
Not following a budget
Each of the examples I referred to above include the use of a budget. However, if you don’t follow any form of budgeting, you are setting yourself up to fail. How do you know if your income truly covers your spending? How do you know if you don’t need to use your credit cards?
A budget will tell you what income is coming and what expenses are going out. This information is truly invaluable. You can use it to see if you need to increase your income or cut back your spending. You can also see how you can build up a savings and pay off debt.
If you are scared of a budget, or don’t know where to start, I highly suggest you watch my free webinar Breaking Through Your Budgeting Barriers. I help you change your mindset around budgeting and set up a successful budget.
Keeping up with the Joneses
Social media is a wonderful and terrible thing! It gives us insight into how our favorite bloggers, celebrities and friends are living their lives. This can cause jealousy, or the need to keep up. The need to keep up can quickly turn into thousands of dollars in debt.
The crazy thing is that you don’t really know what another person’s financial situation looks like. Sure, your favorite blogger is traveling around the world, but is she charging it to her credit card? Is her family paying for it? You will never know. That’s why it is so important to focus on your own situation, not anyone else’s.
If you find yourself trying to keep up with the joneses, I think it’s important to ask yourself why. Why are you trying to keep up with others? Ignore the fact that you don’t really know what they truly have in their bank accounts. Get to the root of why you don’t feel content with what you have. Once you do that, start making a change to get to a place of contentment.
Lack of goals and accountability
Failing to have a vision for the future could result in you living in the now. There is nothing wrong with that, unless your finances are doing the same thing! If you spend money thinking “YOLO”, or “I have time to figure it out”, you are doing yourself a disservice.
Living in the moment with your finances likely means you don’t have a savings and you use credit cards to buy what you want. When you do finally buckle down and decide to get serious, you will have a long road ahead of you.
Even if you are young, start thinking about the things you would want out of life. A nice house, the ability to retire when you want, the ability to pay for your children’s education. Whatever that looks like, let that fuel you to stop using credit cards and start saving money.
Maybe your spending habits are so ingrained that now you need additional accountability. That’s fine, just go get it! Work with a coach or ask a friend to keep you on track. Get the assistance you need to make sure you start sticking to your newfound goals.
The common debt causes listed above can easily be avoided, especially when you acknowledge those causes influence your financial behavior. Start becoming aware of how you think about money, and start making changes where you need to
Trust me, debt-free is the way to be! Have you been guilty of any of the common debt causes listed above? How did you realize it and bounce back? Share your questions and thoughts by leaving a comment below!
The CGS Team