Whatever your goals in life are, you're going to have an extremely hard accomplishing them if you're carrying a large amount of debt. Debt can be daunting, and it's tempting to just make the minimum monthly payments every month and otherwise pretend it doesn't exist. But it does exist, and it's going to be a giant anchor in your life if you ever want to own property, start a business, have a family, or do pretty much anything else in life.
The Difference Between Good Debt and Bad Debt
In an earlier article Josh wrote about career advice
, he mentioned good debt and bad debt. In his examples he used home mortgage as good debt, and credit cards as bad debt. An easy way to think about this, is that is your debt used on appreciating or depreciating assets?
In other words, when you borrow money to buy something, are you spending it on something that will go up in value or down in value?
The mid-2000s housing bubble aside, a home is typically an appreciating asset. When you take out college loans, you're investment in an appreciating asset -- yourself! Your college education should theoretically open new career opportunities that will let you make several times more than whatever debt you're incurring from those college loans. Those are examples of good debt.
So this article will focus on "bad debt." For most people, this pretty much consists of your credit card. Almost everything you would buy with a credit card is something you would immediately consume or something that depreciates in value. The money is spent and you have little to show for it except four or five figures on your credit card balance.
Step 0: Make a Budget
The good news is that your debt is probably a lot more manageable than you think. But the first step you need to take before you do anything is to make budget.
You've probably heard this before, but it's still worth going through this exercise. Look at every single dollar you've spent in the past six months. Sure, you probably spent some money on some frivolous things, but it doesn't matter. That debt has been accrued, it's a sunk cost, and the only thing that matters now is making sure it stops accuring.
Once you've made your budget, categorize everything with one of these labels:
Then ask yourself: which category do you spend the most money on?
Housing often takes up a big chunk of our budget. The bad news is that the only way to adjust this is usually to move, which can be pretty disruptive. The good news is that it's straightforward. Usually your rent is only expensive if you live in a city, and if you do that means there are probably cheaper neighborhoods or smaller apartments available in that said. If you don't have a roommate, consider getting one.
If you're in your twenties, it may still an option to live with your parents. This may put a cramp in your love life (which we've discussed how to mitigate
), but there's no point in being "independent" if you can only do it while in debt. Your debt will enslave you way more than dealing with your parents ever will.
The only pitfall is if you move back in with your parents and then waste that extra money you're saving instead of using it to pay down your debt. Don't do this!
Usually this happens because you bought a cool car when you were younger, but now it's sucking up $450 a month in car payments and killing you at the gas pump -- one of many reasons why you shouldn't buy an expensive car
Depending on when you first bought the car, look into refinancing. Especially if you bought it before 2009 or 2010, it's possible you can refinance to lower monthly payments or a lower interest rate - or both!
Maybe your car isn't that expensive, it's just that you have a long daily commute and fill up at the pump twice a week. If that's the case, consider selling your car and buying a more fuel-efficient one. Hybrids are expensive, but there are a lot of regular cars that still get great MPG (e.g. the Honda Civic hybrid only gets like 5 more MPG than a regular Civic).
This category basically means "stuff you buy at a store." Clothes, electronics, video games, etc. There's not really any good advice I can offer here except for: stop buying as much stuff! If this is really your highest expense every month, you're just buying too much crap. Moderate and pace these purchases.
For guys, this is a very common 'hidden' expense. You may spend $5 or $10 on lunch or dinner every day, thinking it doesn't add up to much, and then realize at the end of the month you've gone through several hundred collars.
If this is the case, try making your own meals. "I don't know how to cook" isn't an excuse -- at a minimum you could just buy some cold cuts at the supermarket and make some sandwiches. Most supermarkets also offer pre-made meals that are usually cheaper and healther than anything you could buy when you eat out. If you stop blowing $10 on fast food every day and buy those instead and the savings will quickly add up.
And if you are inclined at all to learn how to actually cook, there's no time like the present. Cooking is a good hobby
and it's great when you have "come over and I'll cook you dinner" as an option to suggest to a girl you're dating.
Also known as "partying." If you go out a lot to bars and clubs, those tabs can quickly add up. If you're going out, hanging out with your friends, and meeting women, it seems counterproductive to cut back on this. So you probably don't want to go out less often, but just minimize the amount of money you spend when you do.
Here's a tip: take out $60 from an ATM beforehand. Then, only spend this cash when you go out. Don't open a tab on your credit card. Chances are your bar tab gets so high because you got drunk, were having a good time, and thought buying everyone a round of shots would make it an even better time. Maybe it was fun, but it probably also cost you more than all your other drinks combined!
So just give yourself a cash budget every time you go out and stick that. Plus it's way faster paying for drinks in cash, and bartenders appreciate it way more than running and then closing your credit card over and over again.
If your credit card balance suddenly balloons, a lot of times it's because of this. Taking a trip anywhere can easily add up to over a thousand dollars once you add up the flight, hotel, food, etc.
But unless you're taking a transcontinental trip every month, chances are this isn't your highest expense. It only seems like it caused your debt to increase because you had a lot of debt to begin with. The whole point of avoiding debt is to save money that you can spend on the things you really value, like taking trips with your friends. So review all the other sections of your budget and do everything you can to minimize expenses there, so you can maximize your fun and enjoyment here.
This is Half the Equation
Debt is simply what happens when your income minus expenses is negative.
The first step is to reduce your expenses so that this number is no longer negative, but there's a second half to this equation, which is increasing your income. I'll discuss tips for that in my next article, as well as how to make sure your budget is operating at a consistent surplus in reality and not just on paper.