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Eight simple steps to avoid debt


By your mid-thirties, you are far enough along in life to understand that staying out of debt is a key to your longterm financial health. But have you ever sat down and thought about what, specifically, you need to do to stay debt-free? Here are eight simple steps that will help you.

Sarah is 35 and single. She owns a home and lives alone. She is not an extravagant spender. She rarely takes vacations. She always buys a secondhand car. Yet she has trouble staying out of debt, and she has had no success with saving. What can she do to change the pattern?

Step 1: Set up a budget.

By definition, avoiding debt requires that you spend less than you take in. It is just common arithmetic. But while Sarah knows exactly what her income is—she can recite the amount of her biweekly take-home pay to the penny—she is only vaguely aware of her full range of expenses.

Voya’s Home Budget & Savings Calculator can help Sarah understand her monthly expenses by showing her exactly where her money is going. Visualizing her spending is the first step toward managing it.

As with her income, Sarah knows the amount of her monthly mortgage from memory. It’s around 25% of her pre-tax income. She also knows her monthly car payment by heart as well as the number of months before she pays it off (22).

However, Sarah does not have such a strong sense of her discretionary monthly expenses, such as the cost of dining out, or even her fixed monthly expenses. The simple act of plugging numbers into Voya’s Home Budget & Savings Calculator made her realize how little she thought about utilities, home maintenance and general expenses such as food and clothing. Even though her mortgage and car payment are her largest individual expenses, Sarah realized that when she added all her smaller monthly payments together, they exceeded the combined total of those two largest expenses.

So what can Sarah do to bring that number down?

Step 2: Use cash for everyday purchases.

Years ago when Sarah first got a credit card, she started carrying less cash. It seemed to make sense; if she didn’t have cash in her pocket, she wouldn’t spend it. So she used her card for every purchase she could. Soon she was charging almost all of her expenses: morning coffee, lunch, dinner out, movie tickets and so on.

Then she tried an experiment. For a month, she paid cash for all small everyday purchases, saving her receipts as if she was on a business trip. When the month was over, she added up the receipts and compared the total to her typical monthly credit card statements.

She was shocked by what she found. When she used a credit card, she spent far more. The difference was particularly noticeable when it came to food. A single $12 lunch, bought with a simple swipe of her credit card, seemed like a painless expense. But five $12 lunches a week is $60, and that’s $240 a month—more than the total of her car payment.

Once she started using cash and she saw the total amount of her cash dwindling as the week went on, it became easy to decide that she really didn’t need chips and a $2 bottle of water with her lunch. She even started bringing lunch from home a few times a month. At the end of the month, she had trimmed her lunch bill by $100. The conclusion was clear. Sarah knew what to do next.


Step 3: Watch monthly credit card debt more carefully.

For Sarah, this was a natural result of using cash more often and becoming more price-conscious at the point of purchase. She never fully grasped the psychology of it before: Just because she could buy something using a credit card that did not necessarily mean that she could afford it. She now assessed every potential purchase in the context of her monthly budget.

Step 4: Pay more toward credit card bills than the minimum amount due.

That small figure is so tempting. On one of her cards, Sarah has a balance of $1,000 with a minimum monthly payment of just $30. Under her current terms, it would take her 47 months to pay off that debt with a total interest charge of $396.74. If she increased her monthly payment by just $10, she would pay only $262.81 in total interest—a savings of $133.96—and pay off her debt in just 22 months.

Step 5: Pay off the credit card with the highest interest rate first.

If Sarah had a total card balance of just $1,000, she would be in pretty good shape. But she got a second card to collect airline miles, and the interest rate is higher by three percentage points. On the same $1,000 balance, with the same $30 minimum payment, it would require an extra four months to pay off the second card with a total interest charge of $513.97. Therefore, Sarah will save money in the long run if she pays off the card with the higher interest rate first.

Step 6: Pay off credit cards and short-term debt before paying off the home mortgage.

Two years ago Sarah received a small inheritance of $5,000. She used $2,000 to take a trip and used the remaining $3,000 to help pay down her mortgage. Unfortunately for Sarah, she would have been better off using that money to pay off the balance on her credit cards.

This might seem counterintuitive. A home mortgage is the largest debt most of us will incur in our lifetimes. Wouldn’t paying it off first be the wisest way to rein in debt? Not necessarily. Remember, avoiding debt involves effectively managing all of your financial assets. That includes tax deductions, and interest on short-term debt is not tax-deductible but interest on mortgages is.

Step 7: Resist the temptation to use home equity or assets in a 401(k) plan to pay off credit cards.

If Sarah follows steps 1 through 6, this ought to be a moot point. We’ve included it as a point of emphasis. Sarah needs to think of her home and her 401(k) plan assets as protection from risk, not as sources of funding for debt. If she ever reaches a point where she is even thinking of using them to pay off debts, that is a clear indicator that it is time for her to reevaluate her income/spending balance.

Step 8: Do not let credit card payments detract from personal and retirement savings.

Again, avoiding debt means staying within a budget. Thanks to Voya’s Home Budget & Savings Calculator, Sarah realized that trimming her credit card debt was the shortest route to staying within her monthly budget.

Now she has to get into the habit of funneling those savings into her retirement plan, which will also reduce her tax payments. As Sarah has learned, her financial well-being isn’t just a matter of what she makes—it’s about limiting what others take.

Sarah no longer panics about occasional short-term debt. Now that she has a more thorough understanding of her finances, including a viable plan for managing debt while continuing to save, she’s on track to a secure future.

Sarah should also consider whether her employer offers matching contribution on employee salary deferrals when she determines how much to contribute to her 401(k) plan.

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