Living debt-free requires more than managing your current debt. In fact, it begins with avoiding getting in debt as well as thinking twice before financing anything or taking credit even in cases that seem worthwhile.
That is not to say that taking any credit is bad. In fact, for many people maintaining acceptable living standards may not be acceptable without having car financing and a mortgage, for example. But when it comes to almost any credit or financing decision, questioning your need for the purchase item is in order.
Think for example about the option of taking a personal loan for wedding or honeymoon expenses. As much as that is a once-in-a-lifetime experience, the implications of starting your married life with a big loan to pay may not be appealing. If you have an alternative — that is probably more modest for a wedding or otherwise — you probably should go with it and save your peace of mind.
Even on spending items that seem more critical like children’s tuition, taking loans to pay for education is not a sustainable solution. If you don’t have the money now, how do you expect to pay back the loan amount plus interest and charges. In addition, education is a choice that is hard to change down the road. If you select an option that goes well beyond your means now, you may have years of indebtedness and financial struggle.
These are tough decisions to make because they require conscious compromises on the quality of the lifestyle that you aspire to have. But when you get these choices right, you can avoid trapping yourself in a vicious debt cycle. You also will give yourself some flexibility and job mobility because you don’t end up tied down by debt.
There are three easy questions that you should ask yourself before you take out a new personal loan, finance a new car, or spend excessively on your credit to get a high-ticket item.
Is it the only acceptable option?
Look at the item objectively, although that might be hard given your desire to have it. Quality is a relative matter, but you should be flexible as you try to live within your means. An option can’t be acceptable if it totally falls beyond your budget and requires to be financed in full or at a very high percentage.
Instead of getting into this situation, look at alternatives that can be less costly. And see which of them can be satisfactory. You may not like this downgrade initially, but on the long run it may prove to be a wiser choice.
What is the cost exactly?
People often focus on one aspect of the cost — like the monthly payment. If they see that they can afford that payment, for example, they disregard the overall cost of their debt. To make an informed decision, you must look at the cost of your loan. Your lender has to provide you with the total amount of what you will have to pay versus the principal amount. An easy subtraction shows you how much you’re paying in cost.
Couple this cost with the risk of default or charges in case of delayed payment, and now you can see a total of how much your loan may cost you. Based on this knowledge, you need to make a decision as to whether you’d like to proceed with the loan or not.
How will you pay it back?
It is a basic, simple question. You need to make sure that even a small payment every month is doable on the long run. Look at your past bank and credit card statements and see where you can make cuts to accommodate the new payment. If you have been living paycheck to paycheck or on a pretty tight budget, you must identify what can be scaled back consistently to ensure that you will be able to repay the loan.
Don’t just assume that because you will prioritise this payment, it won’t put pressure on your budget. Any extra running cost can derail your budget, so you must think of realistic cuts that will enable you to make these payments.
The writer, a former Gulf News Business Features Editor, is a Seattle-based editor.
How to avoid debt
— Think about alternatives with flexibility
— Know the total cost and potential charges of any loan
— Have a clear plan or how you will make the payments
— R.O.
