In this article:
- 1. Build an Emergency Fund
- 2. Create a Budget and Stick to It
- 3. Develop a Savings Habit
- 4. Keep Track of Your Bills
- 5. Pay Your Credit Card Bill in Full Each Month
- 6. Only Borrow What You Need
- 7. Maintain a Good Credit Score
- 8. Use Caution With Buy Now, Pay Later Plans
Taking on debt for a worthwhile purpose, and making sure payments fit well within your budget, can help you achieve your financial goals. But there are circ*mstances where taking on more debt can be costly and stressful.
These eight tips can help you make sure you're using debt to improve your financial footing, which means taking it on only when it's necessary and affordable, and when it will benefit you. Avoid unmanageable debt by following these tips.
1. Build an Emergency Fund
The top way to prevent debt is to have an emergency fund you can rely on to cover unexpected expenses. When you have cash stored away in the case of a surprise car repair or medical bill, you won't need to use a credit card to cover it.
While experts recommend saving three to six months' worth of basic expenses in your emergency fund, it's also OK to start with a smaller, more manageable savings goal. Having $500 saved can make a difference. For example, if you blow out a tire, you'll have the $200 or so you need to replace it. You'll avoid putting that charge on a credit card, which likely has an interest rate around the national average of nearly 23%, according to the Federal Reserve.
Your best bet is to keep your emergency savings in a high-yield savings account so you can take advantage of high interest rates while having immediate access to your money.
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2. Create a Budget and Stick to It
Credit card debt can sneak up on you if you're regularly making purchases you can't pay off each month. The best way to avoid overspending is to make a plan for each dollar you earn, otherwise known as a budget.
Choose the budgeting plan that most speaks to you. You can divide your spending into needs, wants and short- and long-term financial goals with the 50/30/20 plan or use one account for fixed expenses and another for discretionary spending with the multiple-account plan. No matter which strategy you use, get into the habit of tracking expenses and making sure you're spending less than you earn, and you'll be far less likely to fall into debt.
3. Develop a Savings Habit
Making automatic transfers from your checking to savings accounts will help you build up savings quickly. When you separate that money from your checking account, you're less likely to spend it and potentially go into debt.
You can automate savings for your emergency fund, retirement fund—if you don't contribute directly from your paycheck to a workplace 401(k)—and college savings fund such as a 529 plan debt repayment. The right amount to save depends on your particular circ*mstances, but using the 50/30/20 budget as a guideline, aim to send about 20% of your after-tax income to savings and debt repayment combined.
4. Keep Track of Your Bills
By setting up calendar alerts and bill reminders to pay credit card and loan bills on time, you'll avoid late fees and increased interest charges. Plus, when you miss a payment, you run the risk of a drop in your credit score. That could mean having a harder time qualifying for the lowest rates on credit products in the future, meaning you'll pay more to take on debt.
5. Pay Your Credit Card Bill in Full Each Month
Credit cards make it easy to buy big-ticket items that you can't immediately afford, since you have the flexibility to pay down the balance over time. That can be useful if, say, you suddenly need to make a major home repair and you'd rather not empty out your emergency fund.
But one of the best ways to avoid debt is to look at your credit card like a debit card: Only buy items you know you'll have enough money in your checking account to cover by the time your bill is due. You'll never pay interest and your credit utilization will stay low, potentially strengthening your credit score. But most important, you won't rack up debt that may be difficult to get rid of.
6. Only Borrow What You Need
When you seek a car loan, mortgage, student loan or personal loan, opt for the smallest one possible that will help you meet your goals. Making a sizable down payment on a car or mortgage can lower your ongoing monthly payment. Choosing to borrow through a credit union may help you get lower interest rates on loan products.
Student loans in particular should be considered a last resort to pay for college only after you've exhausted federal, state and school grants; private scholarships; and work-study funds. Fill out the Free Application for Federal Student Aid (FAFSA) for access to federal and state grants and low-cost federal student loans.
7. Maintain a Good Credit Score
Debt may be impossible to avoid if you'd like to buy a house, go to college or buy a car. But you could limit your monthly payments and get a lower interest rate with a good credit score, which is generally considered 700 or above. The higher your score, the more likely it is that a lender will not only accept your application, but that you'll get the best terms possible, saving you money.
Many classic debt-avoidance practices also have the potential to improve your credit score. Keeping debt balances low, paying all bills on time and limiting the amount of new credit you apply for are all key to building good credit.
8. Use Caution With Buy Now, Pay Later Plans
Buy now, pay later (BNPL) is a type of installment loan that lets you pay off a purchase in smaller, fixed payments over time. You may see this option offered by brands like Affirm, Afterpay and Klarna at checkout when shopping online. While BNPL plans may offer 0% interest, depending on the provider, and have less stringent approval requirements than credit cards, they're not always a slam-dunk option.
That's because they open up a lot of avenues for potentially sinking into debt. Each BNPL purchase comes with its own agreement, making it crucial to keep track of multiple new due dates if you already have other BNPL purchases, loans or credit cards to pay off. You may also be tempted to spend more than you would have without the option to buy now and pay later, setting you up for more debt.
How to Pay Off Debt
If you do find yourself in debt, first check your credit report to understand just how much. Then consider these ways to pay it off:
- Consolidate debt using a balance transfer credit card or debt consolidation loan.
- Pay more than the minimum each month using the debt snowball or debt avalanche repayment method.
- Work with a nonprofit credit counselor to build a budget that will help you get rid of debt and, if it works for you, pay down credit card debt using a debt management plan.
No matter the approach you use, it's important to find a strategy that works for you and your unique financial situation. Being too aggressive about paying down debt can quickly result in burnout and, if your goals aren't achieved, disappointment. Even if you're not able to reach your goal of paying down your debt overnight, consistent progress over time is movement in the right direction.
The Bottom Line
Debt doesn't have to be the enemy, especially if you use it strategically and ensure it won't overwhelm your budget. It's possible to make use of financial products that can get you rewards and grow your credit, yet still stay out of debt. Stick to your spending plan and pay off monthly credit card balances in full, and you'll have taken the first and potentially most important steps toward lasting debt freedom.
