In the wake of a menacing recession, U.S. consumers seem to be at a crossroads in debt accumulation and pay-off. While many households have spent the past few years paying off consumer debt, some are seeing a stronger economy and lower unemployment rates as a sign that it is safe to borrow again (despite all of the strides we’ve made in frugality, DIY, and living on less than you make). To bring this reality to the forefront, The Huffington Post reported that consumers borrowed $2.75 trillion in October 2012 — a number that represents an all-time high in America.
Many consumers feel that debt is a cruel cycle that seems to be inevitable for some, yet completely avoidable for others. I can’t count the number of times I’ve been told that “you’ll always have a car payment.” However, reality is that no one should have to be a slave to debt for the rest of his or her life.
Despite that being the case, there unfortunately isn’t a magic potion or quick fix; but with time and persistence, anyone can end the debt cycle for good.
Regardless of how much debt a consumer has — whether $1,000 or $100,000 — there is always a way out of it.
There are many strategies for paying off debt, including some that recommend tackling accounts with the highest interest rates first. While this may be most financially beneficial, financial expert, Dave Ramsey, suggests that it may not be the most effective way to successfully tackle personal debts.
Instead, Ramsey suggests a “debt snowball” plan that requires borrowers to pay minimums to all accounts except the one with the lowest balance. Each month, extra funds are used to pay off the lowest balance account until it is paid in full. Then, the money that was once used to pay down that account will be coupled with the minimum payment on the next lowest balance to pay it off as well. This technique provides borrowers with small debt pay-off victories until eventually, all debts are paid in full.
While most discussions around the personal finance community (it’s even been a prevalent topic here over the past 45 days) center around these debt payoff strategies, consumers forget one of the most fundamental aspects of paying down debt: you have to stop accruing debt before you can pay it all off!
Old habits die hard. Most consumers do not rack up tens of thousands of dollars in debt overnight. Instead, borrowing becomes a lifestyle in which using plastic to pay for both wants and needs is an acceptable practice. In order to break the debt cycle, consumers must first learn how to stop acquiring more debt:
One of the easiest ways consumers get into debt is by purchasing a vehicle. These large purchases seem like needs, but far too often buyers spend more than necessary on a new car. Often, consumers are also led to believe that the costs associated with auto repairs and maintenance are disproportionate to the cost of purchasing a new vehicle. However, all things considered, including payments, interest, DMV fees and higher insurance costs, purchasing a newer vehicle is rarely more affordable than keeping one that is paid off.
Cars are assets that depreciate in value, which is why consumers should put less money in to vehicle purchases and more money into assets that typically increase in value, such as real estate and/or investing in the stock market.
However, consumers who are ready to upgrade — perhaps in an effort to achieve better gas mileage or to purchase a vehicle for a young driver — should try to avoid financing if possible. If that is not possible, personal finance expert, Suze Orman, emphasizes the importance of refusing to finance a vehicle for more than three years. According to Orman, a vehicle that must be financed longer than 36 months is a vehicle that the buyer cannot afford. While we’ve paid cash for each of our recent vehicles, I realize that’s not possible for everybody out there. With that in mind, it is important to shop for rates with multiple banks and lenders before making a purchase. With the help of a car loan calculator, a buyer can easily determine how much car he or she can afford according to these terms.
The final step to slaying debt once and for all is gaining financial protection against the unknown. According to Bankrate.com, reduced income, medical expenses and failure to save are among the top seven reasons consumers fall into debt.
To prevent debt accumulation from a sudden reduction or loss of income, make sure you maintain a significant emergency fund! Here at WSL we suggest having around $2k-5k in cash reserves while you’re working your way out of debt. Once you’ve slayed the debt cycle, then ramp it up to a full 6 months of living expenses and you’ll have a good chance of avoiding the debt cycle if anything were to (eventually) go wrong.
Why don’t more consumers try to avoid car payments? Have you gone further into debt even though you’ve been trying to pay it off? Why might that be?
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The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
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