Five Critical Mistakes to Avoid when Overwhelmed with Debt

by Ken Rupert. 0 Comments

Let me just come right out and say it. Debt is a wealth killer. It robs you of your time, takes away your future and enslaves you those to whom you owe. But debt is not brought on by someone forcing you to use debt to achieve a desired level of life. Debt is really about not having a plan. It is about not proactively considering what might happen and then developing a plan to handle those potential eventualities. Before addressing what not to do after you’ve dug the pit of debt, I want to give you some pointers on staying out of debt.

First, resist the urge to want what you cannot afford. This might seem simplistically logical, but it is the number one driver that causes you to use debt as a tool to inflate your income. Trust me, there are numerous debt brokers out there that are more than willing to set the trap for you. Next, learn the difference between needs and wants and learn to want only what you need. Needs are basic life sustaining expenses: food, clothing, shelter, transportation, and utilities. Beyond that, most of the purchases that are made with debt tend to be consumables; items that once consumed add no further value to life. If you dine out on a regular basis, you will have moments of temporary pleasure. However, over time these thirty minute meals can cost you months or years of payments and interest.

It is true that life happens and in that moment when you are faced with an emergency you can be financially overwhelmed. If your emergency requires more resources than your emergency fund contains, then paying cash for what you can and developing a repayment plan might be the only way to manage your emergency. However, establishing an emergency fund with a built-in mitigation plan for cost overruns is a wise thing to do. Once you establish your emergency fund of three to six months of expenses, set the sustainable target at three to six months of gross income. After that, create an emergency fund for your emergency fund. Put some space between you and life.

Living without debt is really about planning, living below your means, and equating the value of an experience against the cost of that experience. But if you have, for whatever reason, found yourself deep in the pit of debt, you need to avoid these five critical mistakes.

First, avoid using debt as you try to get out from under your debt. You cannot dig yourself out of a pit. One of the biggest mistakes a person can make is to rationalize the use of a home equity loan or a refinance to consolidate credit card debt. The argument for doing this is that you will have one payment with a lower interest rate. In reality, you have extended your debt over the life of a loan that is tied to your house. You are also adding years of interest payments and you have now put the security of your home at risk. In reality, you have just made your consumer debt a necessity by tying it to your house. Don’t fall for the temporary pleasure of using debt to pay off your debt. The math just does not add up.

Second, avoid continuing the same financially irresponsible behavior. Many people who consolidate their debt into a home equity loan or some other form of consolidation loan never address the behavior that put them in debt in the first place. Moreover, they never close the credit card accounts and destroy the credit cards. This basic mistake once again results in the temptation to begin the cycle of artificially inflating their spendable income. Usually, the first several months after the consolidation is made, people will keep their spending in check. But over the course of time, rationalization sets in and the spending is once again resumed. As you reduce your debt you must destroy the credit cards and close the accounts that are at zero balance.

Consider this Judeo-Christian principle; “If your right eye causes you to sin, gouge it out and throw it away. It is better for you to lose one part of your body than for your whole body to be thrown into hell. And if your right hand causes you to sin, cut it off and throw it away. It is better for you to lose one part of your body than for your whole body to go into hell.” (Matthew 5:29-30) Simply applied, if credit cards are causing you to neglect your necessities, then you need to cut yourself off from those accounts. The principle is simple, debt is a wealth killer and it enslaves you to the entity to which you owe. Therefore, failing to sever ties with that entity will result in you being forever committed to working for someone else instead of working for yourself.

Third, avoid rationalizing that you do not have any control over the situation or circumstances. Whether you originally had an emergency fund or not, you must commit to a debt reduction plan that includes establishing or re-establishing an emergency fund. The basic concept is to put aside three to six months worth of expenses to offset a major financial event. I recommend establishing an emergency fund for the emergency fund. The primary emergency fund covers six months of expenses and the secondary fund covers up to three major repairs or replacements to the necessities of life. Those necessities would be shelter and transportation since the first emergency fund covers the expenses of food, clothing, and utilities. Failure to expect emergencies results in failure to manage and mitigate the impact of such emergencies.

Consider your home owners insurance and vehicle insurance as part of the second emergency fund. Therefore, the second fund should be able to maintain several years’ worth of insurance payments along with at least six months of mortgage payments. In addition, it should be able to cover your vehicle insurance for a couple of years. Knowing how to establish and manage your emergency funds is important. Hold the second fund in a state tax free bond fund where it can generate tax free income. Hold the primary emergency fund in a money market account where liquidity is important. Do not make the mistake of not having an emergency fund. Once you are in debt and committed to getting out, you need to set up a smaller emergency fund by setting aside about $1,500 in a savings account. Then pay off your debt, and then build up your emergency funds to the amounts discussed above.

Fourth, avoid over buying items that you absolutely need or purchasing items where the residual costs are somewhat hidden. If you are in debt and you find yourself in need of a more reliable form of transportation, do not over-purchase that form of transportation. Try to find a vehicle that you can afford on cash. Seek help from a family member who might be able to lend you a vehicle or the cash required to purchase one. Do not purchase a new vehicle when all you need is a more reliable form of transportation. Consider having extensive maintenance work done on your current vehicle if doing so would result in increasing the reliability of your current transportation. The key is to consider every alternative before assuming more debt on items you would not otherwise need. It may be a good feeling to drive off the lot in a new car, but the best vehicles to drive off a lot are the ones that do not come with an anchor attached.

Over-purchasing a necessity that requires you to increase your debt is much like purchasing a consumable item. Once the pleasure is extracted, the feelings associated with that purchase quickly pivot from comfort to stress. You need a vehicle with headlights, wipers, and door locks, but you do not need a sunroof, a spoiler or a six CD stereo.

So, first, avoid using debt to pay off debt. Second, avoid continuing in the same behavior patterns that got you into debt. Third, avoid rationalizing that you do not have any control over the situation or circumstances. Fourth, avoid over buying items that you absolutely need or purchasing items where the residual costs are somewhat hidden. Fifth and finally, avoid operating without a well developed and structured asset allocation plan. You have to know what you have coming in and where it is going. It does not necessarily have to be a line-item asset allocation plan, but it does need to document the general categories where you have allocated your income. When you know what is coming in and where it is going, you can begin to identify areas where you can live below your means.

You want to get so good at living below your means that whenever you receive a pay raise, you simply add it to your investment allocation. Set a strategic goal to live off of fifty percent of your pre-tax income. Avoiding debt to the greatest extent possible will allow you to live below your means. This behavior will have residual effects. It will create an abundant spirit that is more willing to bless others. You will have more opportunities to make the right decisions because you will be financially stable. When you become financially stable, you will be more passionate about helping others find the financial freedom that you have found. You have to take advantage of every opportunity wisely. You have to be able to identify a fraud and to avoid the pitfalls that lead to and entangle you in debt. However, if you are currently in debt, have hope. You can begin to overcome the years of bad decisions. Avoid these five critical mistakes and begin to work a plan with someone who has done this before.

If you are considering financial mentoring, then visit http://www.kenrupert.com/Services.html and learn about the different options I offer which might help you. Life is too short to owe others your future. Begin the process today to eliminate your debt, gain financial stability, and leave a legacy to your children’s children. Contact me today to get started.

Leave a Reply