8 Debt Reduction Mistakes Even Smart People Make
Everyone knows it is a good idea to reduce your debt load. With less debt, you save money on interest charges and reduce your risk of financial catastrophe if your income is disrupted and you are unable to make payments. If you don't have enough to make debt payments, you can fund investments and build wealth instead of working to get back to zero net worth.
Some people are much more successful at debt reduction than others. What key mistakes prevent people from paying down your debts?
1. High Interest Accounts
It is hard to pay down the principal on a debt when the interest rate is high. Too much of your payment gets burned up paying interest charges and too little actually goes to paying down the debt.
How to Fix It
Use a balance transfer card to move debt from a high interest credit card to a lower interest credit card, allowing you to pay off the principal faster and get out of debt sooner. (See also: How to Use a Balance Transfer to Pay Off Credit Card Debt)
2. Negative Cash Flow
If your bills and payments are higher than your income, then you are not going to get out of debt! In fact, negative cash flow may be the reason your debt has built up in the first place. There are only two ways to correct negative cash flow: Lower your expenses or raise your income — or both!
How to Fix It
Consider debt consolidation to reduce your total monthly payments, find ways to reduce nonessential expenses, and look for side hustles to boost income.
3. Faulty Repayment Strategy
I was stunned the first time I saw personal finance advisers offering the advice to pay off your smallest debts first. This strategy for paying off debt is called the "debt snowball." You make minimum payments on all of your debts and put the rest of your available money toward paying off the smallest debt. After that smallest debt is paid off, you use the money that would have gone toward that debt to focus on the next smallest debt. This process is repeated until all debt is paid off.
The reason the "debt snowball" strategy is surprising to me is that it is not the fastest way to get out of debt. Simple math shows that you will get out of debt faster and spend less money by paying off your highest interest debt first.
How to Fix It
Having any debt repayment strategy is better than not having a strategy at all. Use the "debt snowball" strategy if this motivates you, but paying your highest interest debt first will save the most money and get you out of debt fastest.
4. Adding More Debt
It you are working to pay down debt, obviously adding more debt isn't going to help. Why would anyone add more debt when they are trying to get out of debt? One reason this can happen is if unexpected expenses pop up and you have directed all available funds to paying off debts.
How to Fix It
Put off taking on new nonessential expenses until after you have paid off debts. Keep some cash in an emergency fund to help avoid using credit.
5. Not Tracking Progress
There is a reason that successful business people are so interested in looking at every financial report that comes out about their business. Feedback is essential to spot problems early and find areas for improvement to get even better results in the future.
If you do not check your total debt on a regular basis to monitor your repayment progress, you might not be making progress at all. In fact, your debt could be growing and you wouldn't know it! You need to monitor your total debt and track how well your debt repayment plan is working.
Once you start making progress in paying down your debt, seeing the smaller debt total every month can be a good motivator to redouble your efforts and get the debt paid off.
How to Fix It
Add up your total debt every month and monitor your debt repayment progress.
6. Not Everyone Is On Board
Many households have more than one person who makes spending decisions. For example, if you are focusing on debt reduction and your spouse is not, then you will probably not make much progress.
I think numbers can be a good way to communicate about debt. Instead of debating purchases and problem spending areas, focus instead on agreeing on the big picture monthly budget numbers. Let each person make their own spending decisions to fit within the budget.
How to Fix It
Get all spenders committed to debt reduction goals and work together to agree on a budget plan.
7. Irregular Expenses
Getting the routine monthly bills under control can be manageable since you know what to expect, but it is easy to overlook those occasional expenses that don't follow a regular monthly billing schedule. For example, budgeting for vacations gives a lot of people trouble. When vacation time comes around, a lot of people end up getting out a credit card to cover at least some vacation expenses. In my house, vet bills are problematic since we have a lot of pets and they need expensive vaccinations and treatments at times. Many years, the vet bill has ended up going on a credit card and moving us in the wrong direction on debt reduction.
How to Fix It
Budget to set aside money ahead of time to cover irregular expenses such as vacations, pet care, and medical expenses.
8. Delay Starting Debt Reduction
For a lot of people, "next month" is always the best time to start debt reduction!
Paying off debts is hard work. You have to track and control spending, and you will likely have to sacrifice buying things you want in order to pay off debts instead. It can be tempting to take another month to plan out your budget and figure out your strategy before you start seriously working on debt reduction.
But delaying another month doesn't provide any advantage to getting your debt paid off. Your debt will hang around and maybe even keep on growing until you take action to turn things around and get it paid off. The sooner you get started, the sooner you will have your debt paid off.
How to Fix It
Start debt reduction now. Don't wait until next month.
Which of these debt reduction mistakes has caused the most problems for you?
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Tagged: Debt Management, cash flow, expenses, interest rates, progress, repayment strategies, snowball method
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I totally agree with everything, but the debt snowball. Yes, you are right about the numbers showing that the debt snowball might not be the fastest way to get out of debt, but the idea is to encourage people to stick with it. If they see debts dropping off then they are encouraged and get excited about paying off debt, which will lead to success. If they are stuck for a long period of time on a high interest debt, they are more likely to abandon ship because they don't see anything happening. The debt snowball is effective because it boast momentum and keeps people interested in getting out of debt. Besides it worked for me and millions of others that bought into the idea of being debt free.
Clarissa, I knew that my discussion of the "debt snowball" method could be controversial since this approach to debt reduction is so popular, but the fact remains that the "debt snowball" method is not the fastest or cheapest way to pay down debt. You can spend thousands of dollars more and take years longer to pay off your debts using "debt snowball" vs. paying down your highest interest rate debts first! I think it is great if people are motivated by the "debt snowball" method and get inspiration from seeing smaller accounts getting paid off, but I think it is important to let people know that the "debt snowball" method may cost more and take longer, depending on the interest rates on your debt. Anyway, I am happy to hear you found your way out of debt!
Just about all of them!
Great list you have here. I believe everybody has his own debt whether is monetary or other things. And learning to control them as entrepreneurs is always one of the key factors for our business to be successful.