Even if you make minimum payments on your credit card, it could take you years to pay off the balance. Credit card debt is tough to pay off because of high interest rates and compounding interest. Once you pay off your credit card balance, the last thing you want to do is find yourself in more debt.
Unfortunately, that’s easier said than done. Only half of Americans have $1,000 in an emergency fund, according to a study from Bankrate. Nearly 40% would use credit cards or other forms of borrowed money to cover an emergency. Life is full of surprises, and it’s easy to rely on credit cards and other accessible debt to cover necessary expenses. However, with active financial management, you can remain debt-free.
In this article, we provide you with five simple tips for how to stay out of debt. We cover the different versions of debt that the average American finds themselves in, as well as different tips and tactics for staying out of debt. No matter if your financial goal is to stop overspending or to put extra money into a retirement account, these tips can help.
The most common types of debt
Before you can stay out of debt, you must first know how to get out of debt. It’s important to understand the different types of debt and how they impact your financial situation.
Credit card debt
Americans have more than $1 trillion in credit card debt, making it one of the largest sources of debt in the United States. Of the available lending options, credit cards carry some of the highest interest rates, often sitting around 16% on average.
Credit cards are what’s known as revolving debt. Unlike some of the options listed below, which have fixed loan amounts, credit cards allow borrowers to use up to a certain amount. This is known as the credit limit. Consumers can spend until the limit is reached.
The problem with credit cards is that interest compounds. For sake of example, let’s say that you have a $10 balance and are charged $1 in interest. Your next interest charge is based on your total $11 balance, so you are now charged $1.10 in interest. To put it simply, you’re charged interest on top of interest.
As soon as you miss a monthly payment or don’t pay your balance in full, your lender charges interest.
More than 60% of Americans have a mortgage. Mortgages are a unique loan used to purchase a home. In terms of dollars, mortgages are the largest source of debt in the United States.
To secure a mortgage, the home you’re buying is put up as collateral. This means that if you defaulted on your mortgage, the bank could repossess your home. This is an example of a secured loan since the debt is backed by collateral.
Of the different types of debt, mortgages often carry the lowest rates — often less than 5%. Mortgages are fixed-term loans, which typically last either 15 or 30 years. Because of the fixed term, interest does not compound. Homeowners know exactly how much their monthly payment is, which makes a mortgage one of the easier types of debt to account for when budgeting.
There is approximately $1.68 trillion in student loan debt in the United States. The rate of student loan debt in the United States grows six times faster than the nation’s economy. Student loan debt is unsecured and is not backed by collateral. Federal loans have fixed interest rates, ranging between 2.5% and 6%.
Whereas credit cards have high interest rates, student loans are plagued by high principal balances. Though student loans have lower interest rates, a student may need to take out thousands of dollars on the loan to obtain their education. Graduates in the class of 2019 took out more than $30,000 in loans on average. This is the highest amount to date.
Though you can easily factor your student loan repayment into your monthly bills, it could take years before you finally pay it off.
More than 44% of Americans use auto loans to purchase cars. Car loans now account for 9.28% of all debt in the United States and are another type of secured loan, similar to mortgages. Should you miss debt payments and default on the loan, the bank can repossess the vehicle.
The rates for auto loans are a tad higher than they are for mortgages, with rates often around 5% to 7%. However, auto loans are considerably shorter in length, with popular options including:
- 60 months
- 72 months
- 84 months
Nearly 70% of auto loans in the U.S. are longer than 60 months. Like mortgages, the payments are fixed, making it easier to build into your monthly expenses.
The last type of debt is a personal loan. More than 20 million Americans utilize this lending option. This is a vague category that covers general purpose loans. Some people use these as a debt consolidation loan, paying down their outstanding debt at a lower interest rate. Others may use personal loans to cover things like medical expenses.
Personal loans are often unsecured, which means the borrower does not need to put up collateral. However, it may result in a slightly higher interest rate than a secured loan because the lender is taking on more of a risk by loaning the funds.
Having said that, there are also forms of secured personal loans available, like home equity lines of credit (HELOC). A HELOC puts up the equity that you’ve already invested in your home as collateral. The money that you receive comes without stipulations. You can use it for everything from home improvements to a vacation.
How to stay out of debt
With different types of debt — like high-interest credit card debt and long-term mortgage loans — it’s easy to see why getting out of debt is so challenging. In fact, two-thirds of Americans believe there is no end in sight when it comes to getting out of debt.
Perhaps part of the reason for this is because many of these expenses are deemed necessary. Unless you’re fortunate enough to be flush with cash, you need a mortgage for a home. Student loans are a necessity for many seeking to obtain a degree.
There are plenty of tips to help you get out of debt, but the tips below focus on how to stay out of debt and manage your personal finances.
Disclaimer: You don’t have to be 100% out of debt for the tips below to help! You may still have a mortgage payment, for instance. But these tips can help you control your spending habits, limit discretionary spending and avoid having to put expenses onto high-interest borrowing options like credit cards and personal loans.
1. Evaluate your past debt
The most important thing to help stay out of debt is to make sure you understand how you got into debt in the first place. Perhaps you had expenses that were essential, like student loans. And sometimes circumstances are out of control when it comes to debt, like unexpected medical bills.
Aside from these situations, you’ll want to note any financial habits, such as living beyond your means, that may have contributed to your debt. Understanding this can help you avoid future missteps and stay debt-free.
2. Build an emergency fund
An emergency fund or a savings account is essential if you’re looking to stay out of debt. You need to be able to cover the expenses that you can’t budget for, like:
- Trips to the hospital
- An emergency pet surgery
- A new transmission for your car
Start by putting $5 per week into a savings account. If you do this for an entire year, you’ll have more than $250 saved. It may not seem like much, but it’s $250 less that you have to put on a credit card. Continue to build this fund over time so that you are prepared when an emergency arises.
3. Set a budget and spend only what you have
A key to staying out of debt is not spending with high-interest debt. To avoid this, you need to have a good grasp on your finances. Take a look at your spending from past months to help figure out how much you’re spending each month. Sort expenses into mandatory and discretionary spending. Your mortgage payment is mandatory, while dinner out with friends is discretionary.
From there, try to pay for everything with only the money that you have. You can do this by paying in cash or using a debit card that’s tied to your bank account. By not borrowing money, you’re forcing yourself to focus on your spending habits. This is an excellent exercise to help you realize just how challenging it is to stick to a budget and why doing so is necessary to stay out of debt.
4. Pick up a side gig
Nearly 50% of Americans under the age of 35 report having a side gig. This is a job that you work in addition to your full-time job. You can use this supplemental income for a range of things. Perhaps you use it to pay down your auto loan more aggressively. Or maybe you use it to build your emergency fund. Even earning an extra $1,000 or $2,000 per year gives you room to breathe financially.
5. Cut unnecessary expenses
We live in a subscription-heavy society. From Netflix and Spotify to gym memberships, you could find yourself being charged a couple hundred dollars per month. The odds are probably pretty good that you’re not using all of these subscriptions each month and that you can afford to get rid of a couple of them. There are multiple apps available that track and manage your subscriptions.
Additionally, take a look at your cellphone bill. Perhaps you don’t need an unlimited data plan or all of the minutes you’re paying for. Cutting $10 per month from your phone bill adds up to $120 saved per year.
What to do if you’re slipping back into debt
If you’re trying to stay debt-free but find yourself slipping back into the cycle of debt, a credit card payoff app, like Tally, could help. Tally gives you access to low-interest revolving debt and uses it to automate your credit card payments.
Tally pays your highest-interest forms of debt first to save you the most money. All you have to do is make a single monthly payment to Tally. It’s an effective option to get out of debt quickly and stay out.
Stay out of debt once and for all
Two-thirds of Americans may be overwhelmed by the prospects of getting out of debt, but you don’t have to be one of them. There are multiple tools available to help you get out — and stay out — of debt.
Some debt is challenging to get out from under. You’re not paying off a 30-year mortgage in a year, just like you can’t pay off thousands in student loan debt overnight. But if you avoid revolving debt from high-interest options like credit cards, you put yourself in a better position to manage your debt.
Once you have your debt under control, you can do things like pay only in cash or pick up a side gig to help stay out of debt.