How to Break Free From the Debt Cycle and Regain Control of Your Finances
Borrowing has become a way of life for many of us. Going into debt is easy. You can accumulate thousands of dollars of debt in only a few months, but it takes years to pay it off. Some forms of debt are actually useful because they allow us to get resources that we can invest in our future, but student loans and mortgages can take a substantial part of your monthly income. You get used to it. You know you’re not alone. It’s normal. But this also means you might end up living paycheck to paycheck, and any emergency can trap you into a debt cycle.
When you add credit cards, auto loans and payday loans – all of which are aggressively advertised to consumers – you can see how things can spiral out of control. Getting out of debt can be very difficult, but it’s doable. You will need patience and discipline. If you’re struggling with debt right now and you don’t know how to regain control of your finances, this article will take you through some of the most effective strategies.
Understanding the Debt Cycle
When you spend more money than you earn, you go into debt. At a certain point, the cost of interest rates can put significant strain on your monthly expenses so you can barely afford to make the minimum payments. This can make your debt increase faster, and if you can’t adjust your budget, you end up taking more loans in an attempt to pay off existing loans and keep your financial situation from spiralling out of control- the debt cycle.
If the cost of interest rates and penalties make it too difficult for you to repay the principal - the initial amount of money you borrowed – you’re in a debt trap. This usually happens when the minimum payments on existing loans exceed 25 to 50% of the borrower’s monthly income, so they are not left with sufficient funds to cover their living expenses.
Face Your Debt
Even if you can still afford your monthly debt payments, you’re treading on shaky ground. Your debt is limiting your lifestyle decisions. You might want to make career changes and move to another city or country. This is too risky when you’re in debt. Events that are out of your control like a medical emergency, losing your job or your car breaking down can destabilize your budget. The only way to regain your freedom and control over your life is to get out of debt.
The first step is to face your debt. Before you start considering your options, you’ll need to find out how much debt you have accumulated and how much this debt is affecting your finances. Calculating your debt-to-income ratio will give you a clearer picture of how much of your income goes towards paying off your debt. Your debt-to-income ratio results from dividing your monthly debt payments by your monthly income, and it’s used by lenders to assess a person’s ability to repay a loan. A high ratio would suggest that the applicant may struggle to pay off the loan, so approving the application is a risky investment.
Analyze Your Budget
Once you know how much your debt is taking out of your monthly income, you’ll need to analyze your budget to figure out how you can adjust. In the initial phase, you’ll want to focus on keeping track of your spending habits, so you can figure out where the rest of your money is going. You can do this by simply taking notes on your smartphone or a traditional notepad. Write down everything from utility bills to coffee. If you buy a stick of gum, you’ll still want to write it down. You’ll be surprised how small but frequent purchases can take a toll on your budget.
The good part is that it’s a lot easier to make small changes to your lifestyle. Let’s say you like to pass by a coffee shop every morning before work. This is not a necessity, but it is something you enjoy. Considering your current circumstances, this might be a small pleasure you can sacrifice for the greater goal of regaining your financial freedom. You could make your coffee at home and take it with you. Whenever you have to make these changes, keep in mind that this situation is temporary. You may have to cut back now, but this doesn’t mean you’ll have to live the rest of your life like this.
Negotiate With Creditors
If you’ve fallen behind on your monthly payments, chances are that you’re creditors or collection companies are calling you day and night. Instead of dodging their calls, you can offer to renegotiate the terms of your loan. Even if they haven’t started calling you, you can take the initiative and call them yourself. Alternatively, you can contact a company that specializes in negotiating better terms with your creditors on your behalf. You’ll probably meet with a credit counsellor who will explain the various debt relief solutions that fit our circumstances.
These negotiations won’t make your debt disappear, but they can lead to lower interest rates, lower account balances and more affordable monthly payments. This will make it a lot easier to get a handle on your debt. For instance, if you have credit card debt but your credit score is still reasonably good, you can get a personal loan with much lower interest rates. Then you contact your credit card company and tell them you want to settle your debt. You may be able to get them to reduce the balance because they’ll be getting the entire amount owed in just one lump-sum or a maximum of three payments. You’ll save money by lowering both interest rates and your balance.
Save for Emergencies
Telling you to save for emergencies while you’re trying to pay off your debt may seem counter intuitive because you’re already trying to channel everything you can save towards getting out of debt faster. Still, an emergency fund can provide a much-needed safety net that can help you stay on track and prevent accumulating more debt. Often, people get into debt, precisely because of unexpected events that destabilize their budget. Since you’re already cutting back on your expenses, you can put a small amount aside that you can use if something happens.
Ideally, an emergency fund should cover 6 to 12 months of your living expenses, but right now, try to set aside a few hundred dollars over the course of a few months. It will already be budgeted for, and it will give you some reassurance.