Financial

8 Strategies for Breaking the Debt Cycle (Part 1)

This blog post is part one of two about breaking the debt cycle. Stay tuned for part two next week.

Getting out of debt often feels like an uphill battle. One month you receive a bonus at work that helps you pay down your balances, and then the next you have a big car repair that brings them back up. One step forward, one step back. This is what we call the “debt cycle.” While getting out of the debt cycle is challenging, identifying and committing to a few strategies can help ease the process.

Stop Using Your Credit Cards

Credit cards can be a great tool, but they are also tricky. One aspect has to do with how your brain perceives balances on your credit card as opposed to your bank account balance.

As you spend on your debit card, your bank account balance drops. That doesn’t feel good. But for credit cards, as you spend your balance goes up. Strangely, this increase doesn’t register the same way in your mind and doesn’t create the same uncomfortable feelings. 

Transitioning away from using your cards can be a challenge, but here are some tips to make it easier:

  • Take your cards out of your wallet and give them to a trusted friend or family member

  • Unlink your cards from convenience apps like Uber and Doordash and online shopping sites like Amazon

  • Forget about chasing points. They aren’t worth the interest and larger minimum payment

You might not get this 100% right from the start and there are circumstances in which you may need to use your credit cards if you’re out of cash. Therefore, if you truly want to break the debt cycle, you need to also work towards having an emergency fund.

Build an Emergency Fund

Building an emergency fund in a high yield savings account is the best way to break the debt cycle. While it may seem counterintuitive, focusing on building your emergency fund is the most important step in getting out of debt and staying out of debt. This is an example of “paying yourself first.” If you constantly use all of your spare cash to pay down debt and something major or unexpected comes up, you have to rely on your credit card to pay for it. That keeps you locked in the debt cycle.

Although you won’t earn a ton of interest in your bank account relative to the interest you are paying on your debt, it’s worth building up your cash as an insurance policy against needing to use your cards in the future.

The Debt Avalanche Approach

There are still ways to be mindful of the interest you’re paying on your debt. That’s the idea behind the debt avalanche approach. The debt avalanche approach is when you put an extra payment towards your highest interest debt on top of the minimum payment. For example, if you are already saving for your emergency fund and have an extra $500 to put towards debt, pay that on your highest interest debt rather than spreading it across multiple cards. Once the highest interest debt is paid off, you will contribute the minimum payment amount and the extra payment to the next highest interest-bearing debt. Then the cycle repeats until all your debt is paid off! This is mathematically the best way to pay down debt if you can make additional payments.

The debt snowball method is another option for paying down debt. Instead of working on the highest interest debt, extra payments are made to the smallest balance debt. This method works well for a lot of people. It comes down to knowing yourself and using whichever method works for you! 

Debt Management Programs

Debt management nonprofits work with your creditors on your behalf to help lower interest rates, fees, and sometimes monthly payments. They help you keep your credit from suffering if you’re struggling with your monthly payments and can work with you to create better cash management habits. They do generally require you to close most, if not all, of your cards while you are in the program. Rather than sending payments to all of your creditors, you make one monthly payment to the debt management nonprofit and they disburse the payments to your creditors. By the time you complete the program, you will have all of your enrolled debt paid in full.

Don’t confuse debt management with debt settlement. Debt settlement companies will negotiate settlements with creditors on your behalf. They will often ask you to stop paying your creditors and pay them instead to start building a lump sum of money that they can use to settle with your creditors. This can quickly tank your credit score.

Come back next week for another 4 strategies for breaking the debt cycle!



Source
8 Strategies for Breaking the Debt Cycle (Part 1) is written by The Financial Gym Team for financialgym.com

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