Update on Tuesday, June 23, 2020
When it comes to debt, most of us have outstanding balances of one kind or another, whether for our car, our home or our education. And while debt can be a necessary tool to achieving certain goals, most Americans (nearly 60%) report feeling weighed down by what they owe, a February 2020 survey by LendingTree found.
But you donâ€™t have to be tied to that borrow-and-repay cycle forever, especially if you have a stable income with cash flow to get ahead of your debt. The benefits of living a debt-free lifestyle can be life-changing â€” reduced financial stress, more money for saving and no interest payments, among them. Here is our guide on what you need to know about living a debt-free lifestyle.
Funneling extra cash into your debt is the quickest way to become free of it. The amount of interest youâ€™ll owe overall will shrink, and so can your repayment timeline. But finding spare dollars to increase your payments can be tricky when you donâ€™t know what money is coming in and going out. Making and following a budget could solve this issue.
Budgeting requires that you list out your income and subtract all expenses (such as rent, utilities and groceries) for the month. Whatâ€™s left represents how much you have to allocate toward your debt. If you come up with a negative number, it means youâ€™re running in the red and need to make some lifestyle tweaks to avoid going even further into debt.
Maybe you notice, for instance, that youâ€™re buying lunch three times a week, paying for four different streaming services or splurging on new tech every other month. These are budget items you could easily reduce or eliminate to free up even more cash for paying off your debt.
It may seem a tedious process to track every dollar, but there are a variety of strategies and digital tools you can use to make it easier. For example, apps like Mint and YNAB (You Need a Budget) link up to your bank and credit card accounts to help you track spending.
When youâ€™re in a stable financial situation and looking to become debt-free, overspending on wants can be a common hurdle when maximizing debt repayment. This can be as small as charging more purchases to your credit card than you can afford to repay, or as big as taking out a large auto loan to pay for a car beyond what you can afford.
It takes discipline to break your spending habits and refuse yourself the things you want so that you can achieve your bigger goal of becoming debt-free. Buying only what is absolutely essential prevents you from adding to your debt and frees up more of your income to channel into paying off debt.
But this will be challenging to stick to, especially if it takes you a couple years to rid yourself of debt, so it is important to occasionally reward yourself for good behavior so you remain motivated. You might decide that after every few weeks youâ€™ve gone without unnecessary purchases, you can splurge on a treat under a certain monetary threshold, say $100, that you know you can afford.
If youâ€™re tempted to buy nonessential items, leave your credit card at home and carry cash: This way you canâ€™t spend more than the dollars in your pocket. If online shopping gets you, remove all saved credit card and payment information from the websites you visit, unsubscribe from promotional emails, and mandate a 24- to 48-hour waiting period before you buy, giving you time to weigh how important that purchase really is.
As we mentioned above, limiting unnecessary purchases, like meals out, can help you put more money toward debt repayment or avoid new debt. But if such tweaks arenâ€™t freeing up enough cash to meet your debt repayment goals, your necessary expenses may have to change if you expect to have a debt-free lifestyle in the long term.
For instance, housing will always be a cost you have to pay, but the amount you spend can change big time depending on square footage, location or number of roommates. It may be worth sacrificing some space, privacy or convenience to find cheaper lodgings that will leave you with a decent amount in your bank account after bills so you can pay off debt.
Review your gym membership, subscription services, cable package, utility providers, cell phone service and any other fixed expenses you deem essential. Try renegotiating or changing providers to get a lower rate, find a less-premium option or cancel the service altogether. Limiting spending is the only surefire way to achieve a debt free lifestyle.
When living debt-free, having an emergency fund is imperative to avoid falling into debt over unexpected costs, like a home repair bill. Set your sights on socking away three to six monthsâ€™ of take-home pay in an emergency fund. Self-employed or freelance workers with variable income may want to tuck away a bit more â€” about nine monthsâ€™ worth of expenses â€” to cover any earning lulls, as well as any surprise bills.
Keep your fund in a high-yield savings account. You could earn better interest than with a typical checking account, while still being able to easily tap the money whenever you want without incurring fees or time delays.
Both do. Just because you have competing money goals doesnâ€™t mean you have an either/or situation. You can achieve both at the same time.
An emergency fund is key to avoiding acquiring more debt when an unexpected event occurs. Press pause on your hefty debt-payoff efforts for a brief spell to focus on building a $1,000 foundation for your emergency fund. Once you hit that milestone, you can resume tackling your debt until itâ€™s knocked out, at which point you can switch back to building your savings up to the three- to six-month mark.
Retirement savings shouldnâ€™t be put on hold, either. You donâ€™t want to be so laser-focused on paying off debt that you rob your future self of a comfortable retirement. If your company offers matching contributions to retirement saving accounts, like a 401(k), you should prioritize stocking enough away in those accounts to get the full match. Otherwise, youâ€™re turning down money from your employer.
Whenever you borrow money to finance a purchase, you must pay back the lender that original sum plus interest and other fees. The interest rate will change depending on the lender and the kind of debt, but it is always a percentage of the loan amount. (Many lenders charge compounding interest, meaning you pay interest on the interest you owe each month.)
Avoid debt and you skip having to pay interest altogether, meaning the cost of any item youâ€™ve bought is the actual total cost youâ€™ll pay for it. Those carrying debt balances with high interest rates will really feel the impact of becoming debt-free on their purse strings.
For example, letâ€™s say you have a $3,000 balance on a credit card with an 18% interest rate and a $125 minimum monthly payment. Hereâ€™s how long itâ€™ll take you to get out of debt and how much interest youâ€™ll pay if you put up that minimum each month, versus a higher sum.
|Your monthly payment||No. of months needed to repay the debt||Total interest paid||Total repaid||% of payments that went to interest|
To put into perspective how valuable these kinds of savings are, consider this: If you took $400 that you were spending each month on debt and redirected it toward a Roth IRA, it would grow to more than $487,000 over the next 30 years, assuming 7% annual returns, if compounded monthly.
While avoiding debt and living a debt-free lifestyle may be a healthy way to manage our finances, it doesnâ€™t mean you should swear off credit altogether. You will likely need to borrow again at some point to afford a large purchase like a new car or home, and having a good credit score is the key to landing those loans with an affordable interest rate.
A number of factors go into determining your credit score. For example, 15% of your FICO Score is determined by the length of your credit history. New credit makes up 10% and having a mix of credit counts for another 10%. In other words, actively using credit responsibly accounts for 35% of your credit score. Going completely credit-free translates to a thin credit file that can impact important financing options down the road.
The good news is you have two major options if you donâ€™t have to sacrifice a debt free lifestyle to maintain a good credit score: