How to Avoid Landing in Debt

    Avoiding DebtThe best way to avoid debt is to be proactive about managing your money.

    Avoiding debt requires you to establish a sound financial plan and steer clear of the foolish whims that bring short-term satisfaction, but long-term hardship on the bank account.

    It’s easy to run up enormous amounts of credit card debt by purchasing things you really can’t afford. Americans owed $979 billion on their credit cards at the end of 2016, or about $8,377 per household.

    It’s also commonplace to let student loans ($1.34 trillion owed), car loans ($1.2 trillion) or mortgage payments ($8.5 trillion) threaten your financial stability. After years of unpaid bills and inadequate resources, bankruptcy might be the only option.

    Don’t go there.

    Take a proactive approach and make better use of your time and money. That could allow you to pay for college, maintain steady employment, perhaps launch a small business and purchase a car or home without fear of them being repossessed or foreclosed. It pays to take some initiative, start early and protect your finances.

    Limit Amount of Student Loans

    The importance of a college degree can’t be overstated. The Economic Policy Institute said that in 2015, college graduates earned 56% more than those with only a high school diploma. A Georgetown University study says that over the a lifetime of work, the college graduate will make 85% more than high school grads. The same study predicted that 63% percent of American jobs will require a post-secondary education or training by 2018.

    To prove the point, college grads have seen a 21% increase in employment since the 2007 recession, while high school grads have seen an 8% drop.

    Finding a way to get that college education is paramount and sometimes that includes taking on debt. But if you’re not careful, what seems like a long-term investment could become more costly than rewarding.

    According to the 2015 National Financial Capability Study (NFCS), released by the FINRA Investor Education Foundation, student loan debt has skyrocketed. In 1993-94, about half of bachelor’s degree recipients graduated with debt, which averaged more than $10,000. In 2017, more than two-thirds of college graduates had debt with an average at graduation of about $35,000, meaning the figure had more than tripled in two decades.

    “It doesn’t seem like a problem when you consider people have debt, but they are investing in education, so there’s an asset correlated to the debt,’’ George Washington University professor Annamaria Lusardi said. “Managing the debt is the problem because it comes at a higher interest rate than the asset. Young people have to be savvy when they start their economic life in debt because that can raise all kinds of issues.’’

    That’s where being proactive can pay off. There are more economical ways to arrive at the same bachelor’s degree.

    Only Use Loans for Academic Expenses

    It might sound ridiculous, but college students must use student loan funds only for education-related expenses, such as classes and textbooks. Too many of them spend student loan money on clothes, furniture, food or other consumer goods.

    Don’t do it.

    It will only increase your levels of debt. Instead, make a personal budget and divide the expenses into two categories — education costs and experience costs. Be sure to classify your “experience’’ costs as things that have nothing to do with earning a degree — such as joining a fraternity or sorority. You will have plenty of time for fun once you line up the dream job and earn a salary that can tolerate “fun” spending.

    Another consideration: Reduce your need for loans by taking on some sort of job, at least a part-time gig that might amount to five or 10 hours per week. You might think the time is better spent studying and keeping your grade-point average as high as possible, but pulling in some extra money to avoid debt is more productive.

    Two-Year Colleges Are Viable Option

    Tuition costs to earn a bachelor’s degree from a private four-year residential school can run as high as $200,000 for top of the line schools. A four-year stay at an in-state college will run closer to $100,000.

    There are more economical ways to get an education.

    Two-year schools — community colleges or technical schools — have similar programs at a much smaller cost than a four-year institution. For the 2016-17 school year, average annual tuition and fees for a two-year school was $3,520. Average annual tuition cost for a four-year school was $9,650.

    That’s a 63.5% increase for foundation classes. Add in the expected cost for room and board — — $11,890 at a private school; $10,440 at state school – and there is a lot of money to be saved by living at home and attending a community college for two years.

    In the fall of 2015, there were 6.3 million students enrolled at public two-year colleges, including 2.3 million as full-time students (24% of all undergraduates attending college). For all students who earned a degree from a four-year institution in the 2015-16 school year, 49% spent some time at a two-year school in the past 10 years.

    Take AP Classes in High School

    By taking Advanced Placement classes in high school, it allows you to get college credits without the cost of tuition.

    If you take as many AP classes as you can in high school — perhaps enrolling in a few junior-college courses on the side — you could slice a year off the time needed to earn a college degree and save about 25% in costs.

    Most AP courses are worth three to six hours of college credit. According to the criteria of most colleges, 30 hours are needed to be considered a sophomore.

    In 2015-16, 69% of high schools offered AP or International Baccalaureate courses with total enrollment of 3.5 million students. The number of students taking AP exams for college credit has doubled over the last decade.

    Be Smart About Education

    You don’t need to graduate from an Ivy League school or a brand-name university to be hired.

    When you are in school, it often pays to choose a marketable major. Advanced degrees in the humanities can be fulfilling, but it might be difficult to get hired with that degree. It’s also useful to augment a general major course of study — say, liberal arts or mass communications — with a more job-specific minor such as finance.

    These days, science, math and computer related majors often lead to quick hiring after graduation.

    Military Benefits

    Military service — or benefits derived from the service of your parents — can help to defray many of your educational costs.

    Some of the benefits:
    • Post 9/11 GI Bill: Provides up to $17,500 per year in financial assistance to military personnel, veterans and dependents. The benefits can even be transferred to spouses or children.
    • Yellow Ribbon Program: It helps with out of pocket costs that aren’t covered by the standard Post 9/11 GI Bill. Basically, your school splits the difference with the Veterans Administration.
    • Military Tuition Assistance Program: Also helps with out of pocket costs.
    • Scholarships and Grants: There are numerous available for military personnel at most colleges.
    • Servicemembers Opportunity Colleges: The SOC is a group of nearly 2,000 colleges and universities that offer more affordable education to military personnel, their spouses and dependents.
    • DANTES Credit by Exam Program: It offers credit to military personnel or veterans who can prove they already have the knowledge that participating undergraduate college courses would provide to them. If military personnel pass the associated DANTES test, they receive college course credit, thus saving time and money.
    • Montgomery GI Bill: It offers up to 36 months of education benefits, including college degree programs, flight training, on-the-job training or correspondence courses. The benefits are available for up to 10 years following release from active duty. There’s also a version for members of the reserves.
    • Veterans Educational Assistance Program: For every $1 you contribute to your VEAP account, the government provides $2 of additional money. Have you heard of a stock, bond or other investment that provides a 2-to-1 guaranteed return? Didn’t think so. This is an account that should be maxed out. The funds can be used for up to 36 months of educational training. And if you haven’t used all the funds after 10 years, the money you originally invested will be returned to you.
    • Survivors and Dependents Educational Assistance: It’s used for sons, daughters and spouses of veterans who were killed, totally disabled, captured by a hostile force or detained by a foreign government.

    Seek Scholarships and Grants

    Student loans are a readily available alternative. Make no mistake, companies will sign you up very quickly if you want to borrow money.

    If you are willing to write personal statement letters and fill out applications — to avoid potentially crippling debt, who wouldn’t be willing? — there could be thousands of dollars in scholarships or grants available to you.

    In the 2015-16 school year, there were $46 billion of scholarships and grants awarded by the U.S. Department of Education, along with the nation’s colleges and universities. There was $2.9 billion of scholarship money that went unused.

    According to the College Board, about two-thirds of the nation’s full-time students received some sort of financial aid through scholarships and grants.

    There are scholarships available for academics or even special talents or skills. There are grants from public funding sources, including state and federal awards for low income students.

    Even if you get aid, you should reapply for more after completing your first year.

    Keep Yourself Employed

    It’s not always a given in these uncertain times for several occupations, but one of the best ways to avoid mounting debt is to maintain full-time employment.

    Losing a job can be random, even with apparent disregard for experience or skill level. But anyone can maximize their potential by developing positive work relationships, whether it’s in their office or in their field of work.

    To ensure security, you should maintain a professional level with all your contacts, perhaps giving you future networking leverage. If you need a job, it’s always advantageous to speak to someone you know, getting a foot in the door, instead of making a cold call.

    You should keep up with the trends in your industry by communicating with colleagues and learning from experts. Many industries are changing almost on a daily basis. Those who don’t pay attention could be left behind.

    And to improve the job that you already have, adhere to basic work etiquette such as showing up on time, meeting deadlines and over delivering instead of over promising.

    Small Business Caution

    Fortune favors the bold. That saying is largely true, but preparing to start a small business can create some debt obstacles that are difficult to overcome.

    Close to 50% of small businesses are not successful during the first five years. The biggest reasons are poor credit and insufficient capital, but also excessive debt.

    Prior to starting a small business, you should save enough to handle the majority of your expenses, while avoiding a preponderance of loans and credit accounts.

    It’s better to make conservative spending decisions, even if the business begins to grow. If risks are minimized, the business will navigate through the high levels and low periods of growth without major losses.

    When starting a new business, it’s always advantageous to have money on the side to meet your needs. Don’t depend solely on the new business for your income.

    By creating and sticking to a budget, you will allow room for steady growth instead of being seduced by more pricy options.

    Taxes Can Be a Problem

    In 2015, the Internal Revenue Service collected $1.76 trillion in taxes on individual income, plus $389.9 billion in business taxes. Still, there remained about 14% of federal taxes that went unpaid, even after audits and other enforcement efforts. You don’t want to be on that list.

    Early in your career — if there aren’t any property or investments — taxes might revolve around a W-2 form. Simple, right?

    But as you earn more (and owe more), things become trickier. It’s always best to make tax payments a priority early in the year, even before they are due, to avoid a major problem. You should always make taxes a priority over non-essential bills or payments you can make later.

    If you have overdue payments or can’t manage the bill, contact the IRS and inquire about a partial payment or requesting an extension.

    Don’t ignore the tax debt. Then you will have a world of trouble.

    Car and Homes

    Nothing causes more debilitating debt than loans for a car or home. The Federal Reserve said the auto loan debt reached $1.2 trillion (an average of $28,948) in 2016, an increase of 9% from the previous year, even though the numbers of cars and trucks on the road increased by only 1.5%. Meanwhile, homeowners were struggling with more than $8.85 trillion (an average of $176,222) in mortgage debt during 2016, the highest figure in five years.

    You can make it easier on yourself.

    Consider looking at used cars or paying cash for a car, anything to avoid having the payments exceed your income capacity.

    The difference between a new and used vehicle is $13,000, according to the Federal Trade Commission. You should read reviews about potential problems and research the value of a used car before signing the title.

    Paying cash for a car might seem difficult, but it can be achieved through aggressive savings. And that’s one way to prevent high monthly payments from controlling your life.

    Meanwhile, taking out a home mortgage should be considered even more carefully. Maybe homeownership isn’t the right path — yet — and renting is a better financial option. When you

    are ready, make sure your income covers mortgage payments, but also allows you to make savings contributions.

    When buying a new car or home, be sure you understand debt-to-income ratio. Your debt-to-income ratio must be under 43% to qualify for a mortgage, but financial experts say 35% or less is much more comfortable and will help you avoid debt.

    Have an Emergency Fund

    To avoid debt, it’s always helpful to have an emergency fund. Personal finance expert Laura Adams suggests getting to a six-month cushion as quickly as possible.

    “That’s really essential,’’ Adams said. “Do whatever you can to get there. It adds a layer of security.’’

    When hit by the unexpected — such as medical expenses, major car repairs or a job loss — the emergency fund can be a life-saver. According to the 2015 National Financial Capability Study (NFCS), less than half of American consumers have put aside three months worth of emergency funds to deal with potential calamities.

    Similar results were found through other research, such as a 2014 study by Washington University in St. Louis that indicated nearly half of all Americans couldn’t come up with $2,000 within 30 days to cover a major illness or job layoff, leading to poor social, psychological and health outcomes for the entire household.

    “It’s about forming habits of saving,’’ Adams said. “Even if it’s just putting away $25 a month or $50 a month, it’s a positive. Maybe by the end of the year, you have built an emergency fund of $500. It’s something.

    “If you have nothing, you’re doing to fall back on debt if there’s a car repair or some unexpected expense. Moving from nothing to at least something is definitely a mindset shift. But it starts a habit.’’

    Buy Only What You Can Afford

    Credit card debt has become an American epidemic. The Federal Reserve said the mean credit card debt for American households in 2016 was $5,700.

    Rule of thumb: When in doubt, don’t pull the credit card out.

    “There’s something to be said for not buying something if you don’t have the money,’’ personal finance expert Ric Edelman said. “What a concept, right? We have fallen into a pattern in this country of seeing something, then buying it, even when you really can’t (afford it). That’s not a good pattern at all.’’

    A good place to start is the 50/30/20 guideline advocated by U.S. Sen. Elizabeth Warren, a bankruptcy expert, and her daughter Amelia Warren Tyagi in their book, “All Your Worth.’’

    • 50 — Limit your “must have’’ expenses — shelter, utilities, food, transportation, insurance, child care and minimum loan payments — to 50% of your after-tax income. And here’s another gauge for debt. If a new debt payment still keeps you under the 50% mark, you can probably afford it. This can be a tough one in major cities, where typically nearly half of your after-tax income is needed for the mortgage or rent.
    • 30 — These are the wants. Use 30% of your after-tax income for “luxuries,’’ such as eating out and vacations.
    • 20 — The remaining 20% of after-tax income is used for saving and paying down debt.

    Avoid Unnecessary Balance Transfers

    Balance transfers — or shifting your credit card debt to a card with a rate that’s lower or even 0% — can seem like a viable option. In some cases, it works. But on other occasions, it’s prolonging a fundamental problem and perhaps making it worse.

    If you’re able to pay down your debt or eliminate it completely, it makes no sense to try a balance transfer. You could be paying fees with no benefit.

    Make Credit Card Payments on Time

    Do not be late. If you miss the deadline for your credit card payment, you will incur fees and high interest charges, starting a cycle that may never end.

    It’s most efficient to use your credit card for convenience — not credit — and pay the balance in full each month.

    Can’t do it? Then you may be buying things you really can’t afford.

    By settling for the minimum payment each month, you will cost yourself thousands of dollars over time.

    “The best advice is to make the payment on time and pay the whole thing off,’’ Adams said. “Don’t miss a payment — ever. And pay more than the minimum if you can. That will do the best service to your credit score.’’

    Carrying a high credit-card balance from month to month sets off alarm bells. It makes you look irresponsible to lenders.

    Know the Signs of Credit Card Debt

    There are telltale signs that you are going down the wrong road with credit cards. By having that knowledge, you can address any issues before they become full-scale problems.

    Here are some tell-tale signs:
    • Creditors are calling to collect payments.
    • You’re making only minimum payments on monthly credit card bills. What’s wrong with that? Plenty. It can take years to pay off a balance — even with a small debt — and the total interest could add up to more than the original debt.
    • Every month, your credit cards are maxed out.
    • You have been rejected for new lines of credit. Either you have too much debt or your recent credit history is damaged. Or both.
    • Your bank account is typically at (or below) $0.
    • After paying bills, there’s no money for basic extras, such as seeing a movie or ordering food.
    • You have taken advances on your paychecks.

    Limit the Number of Credit Cards

    If your credit card debt has spiraled out of control, what’s the solution?

    Hint: It’s not signing up for even more credit cards.

    That’s a short-term fix that leads to long-term problems.

    It’s probably good business to have a few credit cards that are used judiciously. The key is your utilization (your credit limit minus the amount you owe) and keeping it low. That’s a good sign to lenders.

    A good rule of thumb is spending no more than 30% of your credit limit. In other words, if your card has a $1,000 limit, don’t charge more than $300 on it.

    Pay with Cash or Debit Card

    Paying with cash or a debit card is a sure-fire way to avoid going into debt. If you don’t have the readily available funds, the product isn’t for you. This method could teach you how frivolous some purchases can become, while instilling a sense of self-discipline.

    “Modern life can be difficult, especially for the younger people,’’ Houston financial advisor Joseph Birkofer said. “Most starting jobs don’t get anywhere near the expenses of today.

    “Everyone is expected to have a $300 cell phone. Add in your Internet bill, the cable, the rent, the food … and pretty soon most entry level jobs less than $40,000 are just not enough to cover costs.

    “People choose debt instead of going without, so the problem keeps growing. At some point, I think you do have to say that enough is enough.’’

    Compare Prices before Major Purchases

    It’s common sense, but research can save you major money. You can wait on a sale. You can buy a product with more durability for a similar price. You can understand value. There’s any numbers of reasons why you should do your homework instead of quickly jumping.

    Track All Credit Card Spending

    We now live in a swipe-first, ask-questions-later type of society. The proliferation of credit cards has made purchases into an almost mindless activity.

    “The use of non-money credit cards allows people to make impulse purchases without any real sense of the physical cost using hard dollars,’’ Birkofer said. “It’s promoted as a convenience and a quick turnaround on the receivables, but really it continues to lead people to over consume beyond their income levels.’’

    “So much of it is common sense and not putting yourself in bad positions,’’ Lusardi said. “People have almost gotten immune to debt because of the conveniences (of using credit cards). They commonly think they can buy things well above their means. Ultimately, that kind of thinking catches up to you.’’

    If you keep track of what you’re actually spending, you may learn some sobering lessons and get a better game plan for managing your money.

    “We are moving toward a cash-less society and we already see places that don’t accept cash,’’ Lusardi says. “The downturn is what you don’t see, the idea that you can get money out of your phone. You might lose that connection to cost. Just because you’re paying with your phone doesn’t mean you’re not going to pay.

    “If we’re not using cash, we need financial education more than ever. Money is still money. It still comes from the paycheck. The fact that we’re making it more mindless adds to the risk of mismanaging it. Moving forward, people must be very careful.’’

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

    More From This Author
    Get Help Now

    Overwhelmed with debt? You have options for lower monthly payments!

    x