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Pay It Down!: From Debt to Wealth on $10 a Day

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How to Build Wealth After Debt

How to Avoid Getting Back in Debt

Whether you use consolidation, credit counseling, debt settlement, or bankruptcy, getting out of debt usually takes years. One of the greatest and most overlooked challenges is avoiding new debts while you’re paying off your old ones, which can create an endless debt spiral. There are several steps you can take to avoid this:

Examine your relationship with bad debt.
Manage your credit card debt effectively.
Diagnose your spending.
Create and follow a budget.

Examine Your Relationship with Bad Debt

Many people consider debt to be liberating because credit cards and other types of loans allow you to spend more than you have. It seems like free money. This is exactly the type of thinking that you need to reverse in order to avoid a future debt spiral. Keep these points in mind:

People get into debt by spending more than they actually have, usually with the help of credit cards.
People avoid debt by spending only money they have.
Bad debt is not free money. Buying things with credit makes everything cost more in the long run.

How to Manage Credit Cards Effectively

Though credit cards are not the only cause of consumer debt, they’re by far the easiest type of debt to accrue. Some people advise cutting up your credit cards in order to prevent more debt, but it’s much more effective to retrain yourself to use credit cards responsibly.

How to Use Credit Cards Responsibly

There’s only one reason you should use a credit card— convenience. Credit cards are much better than cash for budgeting and recordkeeping. If you make almost all of your purchases with a credit card, you’ll get a documented record of your spending each month and an annual overview at the end of the year. The convenience of credit cards has one main catch—the temptation to make purchases on credit by not paying off your balance in full each month. If you do intend to use credit cards after getting out of debt, you must pay off the balance in full each month.

Alternatives to Credit Cards

Debit cards and prepaid credit cards can give you the convenience of credit cards while eliminating the temptation to spend more than you have.

Debit cards: These cards work just like credit cards but pull money directly from your bank account as you spend it. Debit cards can be a great way to prevent excessive spending: if you don’t have enough money in your account to cover a purchase, it won’t go through. However, if your debit card has overdraft protection, you’ll be able to spend up to a certain amount beyond your actual balance. To prevent this temptation, ask your bank to remove the overdraft protection from your account. All banks offer debit cards, most of which are issued by Visa or MasterCard and work wherever those cards are accepted.
Prepaid credit cards: All major credit card companies offer prepaid versions of their cards. These work like phone cards: you pay for a certain amount of “credit” and then spend it down, refilling the card with new cash when necessary.

If you want to continue using a credit card but are concerned about racking up a balance that you can’t afford to pay in full, another option is to contact your credit card company and request that they lower your credit limit (the amount of money you can charge to the card) to a very low amount, such as $250. That way, you can use the card without the prospect of spending more than you have.

Track Your Spending

People who end up in debt often don’t have a clear idea of where their money goes each month. The process of tracking your spending involves keeping a record of every cent you spend in order to learn exactly how you spend your money. Once you’ve tracked your spending, you can see which types of expenses you should cut back on, and in turn you’ll most likely end up saving money. Tracking your spending involves four steps:

Carry a pocket-sized notepad with you everywhere you go for one month.
Every time you spend money—cash, check, or charge—write down the category and precise amount of the expense. Your categories should include entertainment, food, gas, clothing, personal care, medical care, utilities, and housing.
Every seven days, use a calculator to total your expenses for the week in each category. At the end of the month, add up the weekly totals in each category to see how your spending breaks down.
Once you’ve tracked a month’s worth of expenses, compare the results in each category to assess how you might cut back on your spending. For instance, if you discover that you spend as much on “optional” expenses, such as entertainment, as you do on essentials, such as food and gas, you might consider cutting back on entertainment expenses to give yourself a bit more savings each month. You may even be able to curb your spending on essentials—taking public transportation instead of driving to work, or going out to eat less often.

Create and Follow a Budget

Budgeting is the process of limiting the money that you spend based on your monthly income. Keeping a budget, a detailed plan of how to spend your money each month, will help ensure that you:

Don’t spend more than you have
Have money left over each month to save or invest

You can create a budget using software such as Quicken or Microsoft Money, or you can follow these guidelines:

Add up monthly expenses: Once you’ve tracked your spending for a month, you should have a clear idea of how much you need to spend on each major category of expense. For instance, you might budget $300 per month for food, $100 for gas, and so on.
Add up monthly income: Find the sum of all of your monthly income, including paychecks, investments, or any alimony or child support you may receive.
Compare expenses and income: Subtract your monthly expenses from your monthly income. Your income should be at least $200 greater than your expenses. If it isn’t, refer to your tracked expenses to see where you might be able to cut back.