10 Biggest Mistakes People Make When Paying Off Debt
The decision to get yourself out of debt is a life changer, if you are willing to make the necessary commitment that goes with that.
And if you can avoid the mistakes that could torpedo the whole thing.
Getting out of debt involves more than just paying off a few credit cards. It means changing spending habits; learning to how to budget; knowing who and how much you owe; prioritizing debts; creating emergency and retirement funds; and knowing where to find help when you get off track.
In other words, there are a lot of decisions that need to be made and it’s possible – if not probable – you’ll make some mistakes along the way. Here are some you can avoid that will make it easier to get out of debt.
1. Mistake: Same old spending habits.
People are creatures of habits and spending money is no exception. We shop at the same stores, eat in the same restaurants and drive the same car, because it’s comfortable. It’s also costing you more than you can handle financially. Remedy: If you won’t change your spending habits, you won’t ever get out of debt. Start with your morning habits (have your coffee and breakfast at home). Go to lunch with a brown bag, not a wallet. In the evening, watch games or movies on TV, while eating a home cooked meal. You will see an immediate impact on your daily spending habits. You don’t have to do without. You just have to make better choices with what you do.
2. Mistake: Trying to dig out of debt alone.
People are reluctant to ask relatives or friends for help dealing with debt. Remedy: Call a nonprofit credit counseling agency and get free help from experts. Credit counselors are trained and certified by national organizations like the National Foundation for Credit Counseling. They can suggest debt-relief solutions like debt management programs, debt consolidation, debt settlement or, if things are way over the edge, bankruptcy. The credit counselors advise you on creating budgets and recommend a solution that you can take or leave. And, it’s free! Take advantage of that.
3. Mistake: Signing up for a debt-relief program, but not understanding what is expected.
It is rare to get a quick-fix solution to debt problems. If that is one of the promises you hear, start looking elsewhere. Remedy: The first thing to understand is that debt-relief programs typically take 3-5 years, so be patient. Second, check up on the whatever company you choose for debt relief. The Better Business Bureau or local state attorney’s office are good places to start. Credit unions, universities and military bases should be reliable sources for recommendations. Be sure whatever organization you choose is licensed and doesn’t have a record of consumer complaints.
4. Mistake: Not creating a practical budget.
It is difficult, if not impossible to gain control of your finances unless you have a budget. People think it’s too much work … until they get $20,000 in credit card debt and wonder how in the world that happened! Remedy: Develop a realistic budget that addresses financial needs like housing, food, health care, insurance and education, but still creates room to make payments on debt. Put away the credit cards and only pay with cash. That might mean reducing (or eliminating) things like dining out, entertainment, shopping for new clothes, cars or electronics, but if you’re serious about eliminating debt, operating with a budget and paying cash is a great start.
5. Mistake: Trying to pay off multiple debts at once.
Consumers with multiple sources of debt – credit cards, mortgage, student loans, etc. – often try and address each one every month. Bad move! Remedy: Go back to your budget, trim spending to bare bones on everything but essentials, and create a $100 (or preferably $1,000) surplus that goes directly at the credit card with the highest interest rate. When that’s paid off, go after the card with the next highest interest rate and keep going until all credit card debt is eliminated.
6. Mistake: Closing accounts when they are paid off.
Paying off a credit card balance gives you good reason to celebrate, don’t close the account right away as it may have a negative impact on your credit score. Remedy: The solution to this problem is simple: Pay off the account, but don’t close it. The credit scoring systems rely not only on how much money you owe, but also on your utilization rate, the percentage of your available credit that you use each month. For example, if you have 2 cards with a $1,000 credit limit on each one and spend $300 with each card, your utilization rate is just 30% ($600 spent ÷ 2000 credit limit = 30%. If you eliminate one card and spend the same amount, your utilization rate goes up to 60% ($600 spent ÷ 1,000 credit limit = 60%). It is more valuable to your credit score to have unused credit.
7. Mistake: You decide to stop contributing to a retirement account.
While it seems to make senses to devote every dollar possible to eliminating debt today, in the long run, it’s a costly mistake. Remedy: Contribute at least 5%-10% of your income to retirement savings as soon as you begin working and don’t let eliminating debt cut into that. Time is the most powerful tool in retirement savings. The earlier you start contributing to a 401(k) or other retirement fund, the better off you’ll be at retirement. Find other places in your budget to pay down credit card accounts.
8. Mistake: Not setting aside emergency savings.
According to research, mor than half of American consumers (57%) don’t have enough cash to cover an unexpected expense of $500 or more. Remedy: It’s impossible to predict unemployment, car accidents or busted plumbing, which is why every home needs an emergency fund. Experts say put 3-6 months of expenses aside for emergencies. It might take a while to get there, if you’re focused on paying off debt, but again, it has to be part of your monthly budget. Set aside at least 5% of your income in an emergency fund, at least until you have three months of expenses covered.
9. Mistake: Not verifying your credit report is correct.
Checking your credit report for inaccuracies is an important step in your journey to reduce your debt. Remedy: You are allowed a free credit report from each of the major credit reporting bureaus, Equifax, Experian and TransUnion. Split them up, one every fourth months. Check them closely for incorrect delinquencies and/or balances that hurt your credit score and could make a difference in your ability to buy a house or car, or obtain more credit.
10. Mistake: Not prioritizing your debt.
Everyone has bills and most everyone wants to get out of debt, but some people simply can’t get a focused. It’s not a priority for them. Remedy: The best solution could be to consolidate your debts and make just one payment every month. Another way to get focused would be to take a piece of paper the size of a credit card and write down the five debts you want to get rid of. Tape that piece of paper to your credit card. Every time you reach for that card, you’ll be reminded that you’re adding, not subtracting to the problems on that page.
Picchi, A. (2017, January 12) A $500 surprise expense would put most Americans into debt. Retrieved from https://www.cbsnews.com/news/most-americans-cant-afford-a-500-emergency-expense/
NA, ND. Emergency Fund Calculator. Retrieved from https://www.moneyunder30.com/emergency-fund-calculator