The Benefits of Living Debt-Free

When it comes to debt, most of us have outstanding balances of one kind or another. Indeed, a whopping 80 percent of Americans are living in the red, according to a 2015 Pew Charitable Trusts report — eight in every 10 U.S. adults.

It goes without saying that debt can majorly impact your financial freedom. At one point, Simone Dennis, a 29-year-old health policy analyst in Baltimore, was shelling out in excess of $1,000 a month in minimum payments alone on a combination of auto, student and medical debt.

“I wrote that number down and looked at it every day,” she told MagnifyMoney. “I wanted to escape a life where I was burdened by debt and unable to change my situation because I needed the income.”

In other words, every financial decision she made revolved around her debt. But then she took charge and set her sights on becoming completely debt-free. At the starting line, she owed $65,000 in student loans, had $14,000 left on her car loan and had to contend with another $1,000 in medical bills.

Earlier this month, she reached her goal, wiping out $80,000 in just three years. (We’ll dive into how she did it in a bit.) These days, she’s excited to kick off a life where her income goes toward funding her long-term goals — not the creditors.

The benefits of living debt-free are often life-changing. If your current debt management style is making minimum payments and calling it a day, you might want to perk up and pay attention. Here are all the reasons why living a debt-free life should be your top priority.

What are the benefits of being debt-free?

More funds for your future goals

Unshackling yourself from debt frees up cash that was previously going toward paying down your balances. That means keeping more of your take-home pay. In some cases, it could mean breaking the cycle of living paycheck to paycheck.

Instead of being beholden to creditors, you can use this money to further other financial goals, like building up your emergency fund, kicking up your retirement contributions or whatever else comes to mind. Dennis is using that $1,000 of newfound cash to increase her 401(k) contributions for the employer match. She’s also planning a Mexican vacation to celebrate her accomplishment.

Marissa Lyda and her husband, Jacob, recently crossed the debt-free finish line after paying off $87,000 in student loan debt over a two-and-a-half-year period. This means they finally have some real saving power; getting out of debt has unlocked $750 a month that went toward minimum payments.

“We want to have a full emergency fund and start saving for a good down payment on a house,” Lyda, a 23-year-old accounting specialist in Portland, Ore., told MagnifyMoney. “We’re also putting more toward our retirement accounts.”

You’ll save money in the long-term

You’ll really feel the impact of getting debt-free if you carry any high-interest balances. Let’s say, for example, you have a $3,000 balance on a credit card with an 18 percent interest rate and a $125 minimum monthly payment. If you pay just that minimum, our handy debt payoff calculator reveals that it’ll take you 30 months to get to zero — and you’ll pay $747 extra in interest. These numbers are compounded even further if you have multiple balances and interest rates, which could cost you big time in the long run. (You’re essentially paying creditors to be mired in debt.)

In addition to the immediate financial freedom you can achieve, living debt-free can also majorly supercharge your retirement efforts. Think about it: If you took $400 you were spending each month on debt and redirected it toward a Roth IRA, it would grow to more than $485,000 over the next 30 years, assuming 7 percent annual returns. This mentality could make your golden years a lot more comfortable.

Your health might improve

Another interesting tidbit is that living debt-free may very well be good for our health. Money is the No. 1 stressor in the United States, according to the American Psychological Association’s 2015 Stress in America survey.

Chronic stress can suppress our immune systems and disrupt everything from our digestion to our sleep to our reproductive systems, says the National Institute of Mental Health. There’s also a link between long-term stress and depression and anxiety. It stands to reason that eliminating your debt worries could actually be good for your health.

Risks of debt-free living: How extreme is too extreme?

Conventional wisdom tells us that living without debt is the healthiest way to manage our finances, but this doesn’t mean swearing off credit all together. Doing so, in fact, can work against your financial fitness, according to certified financial planner and senior CFP Board ambassador Jill Schlesinger.

“If you live an all-cash life, then the moment you actually need a loan, you may be in trouble,” she told MagnifyMoney. “It’s highly unlikely you’re going to be able to buy a large asset, like a car or a house, in cash.”

When the time comes to apply for a car loan or mortgage, getting approved — and getting the best rate possible — is wholly intertwined with your credit score. A number of factors go into determining this number. Fifteen percent of your FICO score, for example, is determined by the length of your credit history. New credit makes up another 10 percent; having a mix of credit counts for another 10 percent. In other words, actively using credit responsibly accounts for 35 percent of your credit score. Going completely credit-free translates to a thin credit file that can impact important financing options down the road.

“I totally understand the anxiety of not wanting to live with debt, but going too extreme can be shortsighted,” said Schlesinger, who suggests one of two pathways for maintaining a robust credit score:

  • Use credit cards responsibly: This means paying off your balances in full every month and never carrying a balance. Your credit utilization ratio (i.e. how much of your available credit you’re actually using) makes up nearly one-third of your FICO score. Our experts recommend keeping your credit utilization ratio under 30 percent.

    Reaching for a credit card instead of cash or a debit card to pay for regular living expenses, like gas and groceries, is a great way to use credit to your advantage, so long as you’re paying off the balance in full every billing cycle. (If you can rack up rewards in the process, all the better.) Making on-time payments also shows future lenders that you know how to handle your credit.

  • Consider a secured credit card: Don’t trust yourself with a credit card? Thankfully, there are other ways to keep your credit score alive and well. Enter secured credit cards. These require the cardholder to put down a cash deposit, which determines their credit line, right off the bat. From there, you can use it like a regular credit card without the fear of digging yourself into a debt hole. Not carrying a balance and making on-time payments is key to boosting your credit as your activity is reported to the credit bureaus.

Eliminating debt: How to start

Pick a strategy

Making the minimum payment across all your open accounts isn’t the most effective way to pay down your debt. Dennis used what’s known as the snowball method to get debt-free as fast as she did. This means she continued making the minimum payments on all of her accounts, except for the one with the lowest balance, which she hit extra hard with bigger payments.

Once the lowest balance is paid off, you take whatever you were paying on that bill and apply it to the next lowest balance. It has a compounding effect, plus you can see your accounts closing one after the other, which can make you feel like a financial rockstar.

“I made monthly ‘mega-payments’ of about $2,700 on the debt with the smallest balance and repeated this method until all my debts were paid in full,” said Dennis. “The quick wins of the debt snowball method motivated me to keep going.”

One side note: While you’ll end up paying more in interest over the long haul, this tactic works wonders when it comes to keeping up motivation, according to The Journal of Consumer Research.

Alternatively, you can tackle your debt by prioritizing the accounts that have the highest interest rates. From a black-and-white, numbers perspective, this is smarter than the snowball method since you’ll ultimately get out of debt sooner and pay less in interest. Not sure which method is right for you? Our Snowball versus. Avalanche Calculator can help you make sense of your options.

You can accelerate your debt payoff journey even more by using balance transfer offers. These let you transfer high-interest balances over to new, lower-interest accounts with super-low promotional rates. These typically come with a 3-4 percent transfer fee, but if you can get a 0 percent card and pay off the balance within the promotional period, you can save big time in the long run.

Learn to budget

The key to accelerating your get-out-of-debt timeline is freeing up extra cash that you can throw at your debt. This, of course, requires sticking to a budget. Begin by listing out all your incoming money (income) for the month and subtracting all your outgoing money (expenses), which should include monthly contributions to your savings account. (Don’t worry, you can pay off debt and save at the same time. More on this shortly.)

What’s left represents how much you have to allocate toward your debt. If you come up with a negative number, it means you’re running in the red and need to make some lifestyle tweaks to avoid going even further into debt, which brings us to our next point.

Live within your means

Are there any ways to decrease your expenses? Dennis downgraded her cable package and cellphone plan, stopped paying for garage parking, and cooked meals at home in order to direct more money toward her debt. On a more extreme note, Lyda and her husband sacrificed their personal space and moved in with her parents to kick their debt repayment into high gear.

“We felt very suffocated by debt,” she said. “We weren’t making much, our rent was a lot, and our debt was enormous.”

In addition to lowering your expenses, think of out-of-the-box ways to increase your income, like picking up a side gig. Dennis tipped the scales by selling gently used household items on Craigslist and eBay. She also took on a part-time gig at a local yoga studio in exchange for a free membership.

How to maintain a debt-free life

Once you cross the debt-free finish line, celebrations are certainly in order, but you have to be intentional about not backsliding. Ask yourself how you got into debt in the first place. The way you answer is personal, but pay attention so you don’t repeat past mistakes.

Redirect debt payments toward savings goals

To keep you moving in the right direction, Schlesinger suggests immediately taking whatever you were putting toward your debt and redirecting it to some sort of savings vehicle, whether that be beefing up your emergency fund or upping your retirement contributions.

“It’s a great way to prevent falling back into those bad habits, and the more you can automate it, the better; out of sight, out of mind,” she said.

Top off your emergency fund

If you have nothing in your savings account, you’ll likely rack up new debt to see you through unexpected pop-up expenses. Set your sights on socking away three to six months’ of take-home pay in your emergency fund.

This, along with sticking to a budget, living within your means, and using credit responsibly, plays a major role in breaking the debt cycle once and for all. In some cases, your emergency fund could save you from financial ruin. The good news is that you don’t have to wait until getting debt-free to get your savings off the ground.

Debt versus savings: Which comes first?

According to Schlesinger, there’s a common misconception out there that competing money goals represent an either/or situation. But she says that it’s all about changing your mindset so you can fill more than one bucket at the same time.

“When people ask, ‘What should I do: pay off my debt, establish my emergency fund or contribute to my retirement account?’ my answer is always is the same: Yes!” said Schlesinger. “These big goals require some multitasking.”

If you’re actively in debt-payoff mode, press pause and focus your energy on setting the foundation for your emergency fund. Our insiders suggest setting a starting target of $1,000. Once you hit that milestone, go back to focusing on debt until it’s knocked out, at which point you can switch back to building your savings up to the three- to six-month mark.

Retirement savings don’t have to be put on hold, either.

“If you have 22 percent [interest] credit card debt, it’s hard not to make that the priority, but if you have a 401(k) match, you should put in enough to at least get that match; we shouldn’t be leaving free money on the table,” Schlesinger added.

The takeaway? You don’t want to be so laser-focused on paying off debt that you rob your future self of a comfortable retirement.

What you should do when you’re finally debt-free

Now is the time to ratchet up your savings goals. After bolstering your emergency fund, the next rung on the ladder, according to Schlesinger, is dialing up your retirement contributions — which is exactly what both Lyda and Dennis are doing. Schlesinger said the goal should be to max out your accounts.

Once that’s on track, you can start focusing on other savings goals like travel, saving for a down payment on a home, or saving for your children’s college education. Investing should also be a top priority at this point. We’re not talking about individual stock picking. Instead, the sooner you can zero in on low-cost index funds, the better. This will position you to really maximize your investment returns.

The path to getting, and staying, debt-free is rarely a linear one, but staying the course definitely pays off. The key is to strike a balance between using credit responsibly and sticking to a plan that lets you contribute to your other overarching financial goals.

The good news? A debt-free life is totally doable.

The post The Benefits of Living Debt-Free appeared first on MagnifyMoney.

5 Excuses Keeping You From Being Debt-Free

There are many reasons why you may be stuck in debt and they’re not all necessarily related to the state of your finances. In fact, your money woes may be exacerbated by your mindset. Your beliefs are often what guide you, and if you’re carrying around problematic ones, you’ll have a much harder time getting debt-free.

Here are five excuses that could be keeping you in the red.

1. ‘I Deserve It’

One of the most common phrases debtors bandy about is “I deserve it,” Jeff Jones, a Certified Financial Planner in Huntsville, Ala., wrote in an email. “It’s an excuse and that transcends financial matters … but this usually comes at the expense of a larger, long-term goal.” This mentality, for instance, enables people to reward themselves with a lavish vacation (on credit) or a new car (and the payment to go with it), Jones added, when instead you should be thinking about becoming debt-free or saving more for retirement.

2. ‘I Don’t Know Where to Start’

Facing debt is overwhelming. It involves owning up to whatever got you there in the first place and taking responsibility for paying it off. Add to that the sinking feeling that comes with realizing how much you owe and the whole thing starts to become one sad situation that seems insurmountable. How will you ever get out from under this mountain of expenses? Fortunately, there are options, including, for instance, debt consolidationbalance transfer credit cards or the help of a credit counselor. You just have to be willing to face your debt head on and put the time in to research what strategy may work best for you.

3. ‘I’ll Deal With It Later’

Another day, another excuse. “I’ll draft a budget in the new year” or “When I get a better job, I’ll start paying off debt.” And on it goes. The problem with this mentality is that the timing will never be right. It’s like keeping a diet: If you always find an excuse to get out of it, you’ll never reach your goals.

4. ‘I Only Need to Make the Minimum Payment’

Initially choosing to make only a minimum payment on your loan obligations can be a hard habit to break. “This one is invidious because it anchors you to making a payment, which means that, in the case of a credit card, it will take, say, 10 years to pay off, assuming you don’t add to the balance,” Jason Hull, a Certified Financial Planner in Woodbury, N.J., wrote in an email. “We tend to become attached to the first number we see, so when we see the minimum payment, we assume that’s what we should pay. Instead, we should pay as much as we can on our credit cards to pay them off as soon as possible — and make sure that we’re not adding any more to the balance.”

You can see just how much adding a few dollars to your monthly payment can impact your debt-free timeline using this credit card payoff calculator.

Remember, high credit card balances can damage your wallet and your credit. You can see how your credit card debts may be affecting your credit score by viewing your free credit report summary, updated each month, on Credit.com.

5. ‘I’m Not Responsible’

It’s easy to blame our debt woes on external forces, like car repairs or a medical emergency, but when all’s said and done, we need to take responsibility for our actions. That could mean not living like an upper-class family on a middle-class paycheck, being able to sign off of our favorite shopping sites when we know our credit card bills are already too high and avoiding “friends” who spend to have fun (and encourage you to do the same.) It’s a good idea to try to stop justifying your habits with the idea your debts aren’t your fault — someone got into debt, and whether you acquired it by marriage, co-signing, or on your own, it’s yours, and yours alone, to pay off.

More on Managing Debt:

Image: Alberto Bogo

The post 5 Excuses Keeping You From Being Debt-Free appeared first on Credit.com.