Have you become too comfortable with debt?
Written by Carl Turner on January 31, 2017.
In much of the western world debt has been completely normalised. Once upon a time people saved up for what they wanted to buy but that concept seems increasingly outdated with instant gratification now the order of the day.
Companies from credit card providers to phone companies and major stores are queuing up to offer us lines of credit and interest-free loans and increasing numbers of us are saying yes. Just take a look at this OECD graph showing household debt as a percentage of net disposable income. In Denmark, the most extreme case, average household debt is 300% of income!
But it’s not just luxuries we are buying with credit. With incomes static and the cost of living rising in many areas, it’s not surprising that many people turn to debt to fill the hole. In particular the cost of getting on to the housing ladder poses a problem which explains an increasing trend for first time buyers to fund their deposit on a credit card. This is a risky strategy, to say the least, which exposes those resorting to it to falls in home values which could leave them in negative equity. It also means that an unexpected events such as a job loss due to serious illness could send their finances spiralling out of control.
Just because debt is easy to come by doesn’t mean that we should take advantage of it. Follow this simple ABC of steps to manage your debt and become the master of your money and not its slave.
Assess your spending
Make sure you know exactly where your money is coming from each month, and where it goes. It is amazing how few people know how much they spend on bills, groceries and travel for example. Measuring what goes where will help you manage expenditure more efficiently so start a spreadsheet or use an app to properly monitor everything.
Formulate a plan of attack to pay off your debts. Firstly make a list of all your debts and the rates of interest you are paying on them. Then select one of these two methods to getting them paid off:
- The ‘snowball’ method – this works on the principle that most of us find it easier to keep at something if we see quick, positive results. Concentrate on paying off your smallest debt first and then build on the momentum gained from eliminating that one to tackle the others.
- The ‘avalanche’ method – this method is less motivating but will be quicker and more cost-effective because the compound effect means that debts with a higher interest rate will grow faster. Target the debt with the highest interest rate and pay that one off first and then move on the one with the next highest rate.
Consolidate and cut
If it is possible to consolidate your loans and benefit from a lower interest rate than do so but make sure you don’t fall into the trap of extending the term of the loan. The aim should remain to pay off the debt as soon as you possibly can so determine how much you can realistically afford to dedicate each month to that and stick to that amount. Have a fixed timeframe in your mind of when you will be debt-free and focus on it at all times.
If you do consolidate your credit cards and other loans, make sure that you cut the cards up to eliminate any temptation to use them.
At the end of the day an increasing level of debt is a symptom of consistent overspending. To really gain control of your finances you need to treat both the symptom – by paying off the debt – and the cause – by living within your means every month.
I will soon be publishing my self-help Expatriate Financial Planning Guide called 12 steps to financial success for international expatriates. This will include more practical information on paying off your debt as well as how to proceed once you have achieved that first step to build your wealth. If you would like to be one of the first to receive a copy, please email me with your address.