Do you feel like you’re drowning in debt? When this is the case it’s easy to become confused about what to do about your debts and end up doing things you’ll regret later. While there are numerous ways you can get tripped up when struggling with your debts, here are the 10 mistakes people most commonly make and how to avoid them.
Ignoring your debt
One of the worst mistakes you can make is ignoring your debts. If you let your bills pile up on a desk or in a drawer, you’ll just accrue more interest and late fees. You might even end up being sued, have your car repossessed or if you’re a renter you could be evicted. No matter how awful it might make you feel, you need to open those bills and return any calls you receive from your creditors. And, of course, you need to develop a plan for dealing with those debts.
Trying to manage debt without a budget
It’s just silly to think that you could work your way out of debt without having a household budget in writing to help you cut your spending and better manage your money. There is simply no tool that’s more fundamental to good debt management than a budget. It’s just the only way to ensure that the limited amount of money you have available goes towards paying off your top priority debts and your living expenses.
If you’ve never done a budget, here’s video that explains step-by-step how to do a monthly budget
Falling behind on your car payment
If you fail to stay current on your car loan, there’s a good likelihood your car will be repossessed. And this can happen with no warning whatsoever if you miss just a single payment. You have your car one day and the next you don’t. This gets even worse if you need your car in your job as losing it would be a real disaster. At the very least losing your car would make your life and your family’s life more difficult.
Paying only your most aggressive creditors
If your money is tight and you can’t pay all your bills don’t decide which ones to pay based on those creditors that are the most aggressive and hound you the most. In fact, the creditors that harass you the most may be the ones you should pay last.
Making promises to creditors you won’t be able to keep
When you talk to a creditor about a past-due debt or to discuss how you might catch up on past-due payments, don’t ever agree to pay more than you truly believe you can afford. Make decisions based on your household budget and not what you think your creditors want to hear.
Refusing to stop using your credit cards
This one is such a no-brainer it almost goes without saying. But if you’re having a problem with your credit card payments, put those credit cards away so that you’re not racking up even more debt. If you’re thinking of buying something and you don’t have enough cash to pay for it, just don’t buy it. If you want to be even more cautious, put those credit cards in a plastic bag filled with water and put the bag in your freezer. If you get the urge to use one of those credit cards, then you may change your mind by the time the ice has melted and you can access one of them.
Taking out a loan against your home to pay off debt
If you’re struggling just to get by and have equity in your home it can be very tempting to get a loan by using the house as collateral. But using your home as collateral to get a second loan is just not something you should do. You could ultimately find yourself in a position where you couldn’t make the payments on both loans and would lose your most valuable asset.
Getting a loan from a non-traditional lender
There are actually for-profit credit counseling agencies that will try to talk you into borrowing money from them as a way out of your financial situation. Then there are companies such as finance companies that will tell you that their loans can help you deal with your debts. Never take out a loan from one of these nontraditional lenders especially any that would require you to use your home, car or some other valuable asset as collateral. It could be tempting to get a loan from one of these lenders but you should steer clear of them. Read your paperwork very carefully and it’s likely you’ll find that these loans are a very costly source of cash and that their terms are actually designed so you will end up losing your collateral.
Choosing to work with a for-profit credit counseling agency
There is simply no reason to work with a credit counseling agency that is for-profit. These agencies are in business for one reason only and that’s to make as much money off you as possible. As a result, you can’t trust that their recommendations will be in your best interest. In fact, some of the for-profit credit counseling agencies may tell you to do stuff that earns them money at your expense and could actually get you into legal hot water.
Asking a family member or friend to cosign a loan
If you can’t get a loan from a traditional lender such as a bank or credit union because of your financial issues, think very carefully before you ask a family member or friend to help by cosigning for a loan. The problem here is that if you fall behind on your payments, your primary lender will go after that family member or friend for the money you owe. This would not only put your cosigner in a terrible bind but it could very well ruin your friendship or cause a serious rift in your family.
7 frequently asked questions about debt
Q. Is there such a thing as good debt?
A. Yes, there is such a thing as good debt. For example, a mortgage is considered to be good debt because your home is an asset that will increase in value over the years. Borrowing money to go to school can also be good debt because the education you would receive should help you earn more money and have a better career. In addition, any debt that’s used to acquire an asset that will grow in value could thought of as good debt.
Q. How is debt to income calculated?
A. This is a simple matter of division. All that’s required is to add up all your monthly debt payments and divide the total by your gross income. For instance, if your monthly mortgage payment was $1500, your auto loan payment was $225 and you had $200 in other debts, your total monthly debt would be $1925. If your gross monthly income was $6000, your debt to income ratio ($1925/$6000) would be 32%.
Q. What debt should I pay off first?
A. If you’re struggling to repay your debts the first thing you need to do is take a piece of paper and draw a line down its middle. On the left side of the line write down the necessities of life such as your phone, gas and electricity bills, and your rent (if applicable). Next write down those debts where you were required to provide an asset to collateralize them such as your auto loan and mortgage. Then on the right side of that line write down all of your other debts including credit card debts, personal loans, personal lines of credit and payday loans.
The debts you should pay off first are the ones that are on the top of the left side of the paper. The ones that come after them should be second in priority. The debts on the right side of your list will have the lowest priority because they could be negotiated.
Q. Why is debt bad?
A. As you have read not all debt is bad. In fact, it’s even okay to carry some credit card debt so long as you pay off your balance at the end of the month. Where debt becomes bad is when it becomes so large it damages your credit score making it more difficult for you to get new credit at a reasonable interest rate or any new credit at all.
Q. Is debt consolidation a good idea?
A. Debt consolidation can be a very good idea depending on one factor. And that’s if you can consolidate your debts at a lower interest rate than what you’re currently paying. For example, let’s say you have four debts at 17%, 19%, 14% and 8% yielding an average interest rate of 14.5%. If you were able to get a debt consolidation loan for, say, 8.5% then debt consolidation would be a good idea.
Q. When is a debt too old to be collected?
A. If you have some old debts no debt collector may be able to sue you as they may have become “time barred”. This is because debt collectors have a limited number of years to sue you called the statute of limitations. However, this varies from state to state so if you have some old debts you will need to contact your state’s attorney general’s office to learn how many years is the statute of limitations where you live.
Q. How much debt is too much debt?
A. The answer to this will depend on several things. For instance, if you do the math and find that your debt to income ratio is below 40% you probably don’t have too much debt. On the other hand, if your debt to income ratio is 50% or higher than you’re definitely carrying too much debt. Finally, if your credit score is 680 it’s either because you have too much debt or have failed to make some of your payments.
