November 22, 2022

How to Avoid Debt: Steering Clear of the Debt Trap

We live in a society where it's so easy to get into debt, and it can be hard to tell when you're getting close to the edge. In fact, a recent report by the Consumer News and Business Channel (CNBC) revealed that the average American has about $90,460 in debt.

So how do you avoid falling into the trap of debt in the first place?

In this article, we’ll discuss what the most common debt traps are, how to avoid them, and what you can do if you already have a few debts.

Good Debt vs. Bad Debt

The first step toward avoiding debt is understanding that there are two kinds of debt: good and bad.

Good debt is a tool that helps you earn more money, enhance your life, or pay for something that will increase in value. It typically pays off over time and can include student loans, mortgages, and business loans.

Bad debt, on the other hand, is money borrowed to purchase depreciable assets that don't improve your financial situation, now or in the future. It includes credit card balances or other consumer loans which carry high-interest rates.

The key difference between good and bad debt is how much interest the loan will accrue over time. A loan is considered good debt when the borrower's return on investment (ROI) outweighs the interest cost. However, if the borrower's ROI is lower than the interest cost—meaning they'll pay more in interest than they'll get back in value, it's considered bad debt.

Understanding the concept of good debt and bad debt can help you steer clear of the latter and use the former wisely to improve your financial situation.

5 Most Common Debt Traps

If you want to avoid getting caught in a debt trap, it's important to know what kind of traps exist and how they work. Here's an overview of some common types of debt traps:

1. Credit Cards

Credit card debt is one of the most common types of debt people get into and can trap you in a cycle of high-interest payments and late fees.

You may think it's harmless to use your credit card to buy groceries or pay for gas if you can't afford it—but when you don't pay off your monthly balance, you start paying interest on top of what you already owe.

Credit card companies also offer low rates to attract new customers and rewards to encourage them to spend more than they can afford. The best way to avoid credit card debt is to either limit the use of credit cards (to an amount you can comfortably pay each month) or not get one in the first place!

2. Payday Loans

A payday loan is an advance against your future paycheck. These short-term loans are often marketed as a way to help people through financial emergencies.

However, payday loans come with high-interest rates and hidden fees—which can quickly lead to debt that's difficult to pay off. In fact, more often than not, people end up getting trapped in a cycle where they're taking new loans to cover old ones.

3. Auto Title Loans

Auto title loans allow people who need quick cash to borrow against their cars. However, title loans often have very high-interest rates and fees, making it difficult for borrowers to repay their debts without permanently losing their cars.

4. Overdraft Facility

An overdraft facility allows you to spend more money than you have in your account when making an electronic transaction, such as withdrawing cash from an ATM.

Your bank or credit union will charge interest on these transactions and may also charge fees. Unpaid overdraft amounts can lead to additional charges and bad credit ratings.

5. Rent-to-own

Rent-to-own agreements are often used for major purchases, such as furniture, appliances, and electronics. The rent-to-own company will provide you with an item you can pay for in monthly installments.

You'll usually end up paying more than if you had bought the item outright. That is because rent-to-own companies may charge a large fee and interest on top of the product's price. They may also repossess your item if you don't pay your bill on time.

7 Ways To Avoid Debt

When it comes to debt, we're all in the same boat. It's a problem that affects everyone, from young people just starting their careers to retirees trying to make ends meet.

But debt doesn't have to be your fate, and there are steps you can take right now to avoid falling into its clutches.

Here's how to avoid debt in seven simple ways.

1. Establish a Realistic Budget

A key step to avoiding debt is to get on a budget, which means creating a plan to spend your money.

You need to understand exactly how much money you have coming in each month and how much you spend on essentials and non-essentials. This will help you determine where your money is going—and whether or not you need to make any changes.

2. Live Within Your Means

You can't avoid debt if you're living beyond your means. Sure, there will always be something that comes up and causes us to go over our budget. However, if this happens too often, it is likely time for you to reevaluate your spending habits and find ways to cut back on expenses.

3. Have a Savings Plan

Another way to avoid debt is by having a savings plan which can take many forms. Some people prefer putting money into a savings account every month, while others make sure they're contributing enough towards retirement or investment accounts each year. Others may also put aside money for major expenses like college tuition or car purchases.

Regardless of how much you save, the important thing is having a plan to secure your financial future, so you don't end up in debt later on.

4. Limit the Use of Credit Cards

Credit cards can be a great way to establish and build your credit history, but they are also the most common debt trap.

To avoid debt, try to limit your use of credit cards as much as possible and pay them off every month—that way, you won't be hit with late fees or interest charges.

5. Stay On Top of Your Bills

A major cause of debt is letting bills pile up until they are unmanageable. Make sure you are paying all of your bills on time (or at least within a reasonable amount of time) to avoid incurring late fees or losing out on interest rates because of missed payments.

6. Use Cash, Not Credit

Using cash instead of credit cards can help you keep track of how much money is being spent on things like meals out or clothing purchases. This way, you won't have to worry about how much credit card interest you might accrue from using plastic too often.

7. Create an Emergency Fund

One of the best ways to avoid debt is by having an emergency fund set aside in case something goes wrong. This should allow you to deal with such situations without resorting to borrowing money.

Most financial experts recommend having around three to six months' worth of living expenses saved up in case something unexpected comes up.

If you don't have money set aside yet, start saving now! It may take some sacrifice and patience, but once you get there, it will be well worth it!

What if You Already Have a Few Debts?

Most people have some debt. Whether it's a student loan, credit card debt, or other accumulated debt, it's common to owe money. But when you look at your finances and see that you're in over your head, it can be hard not to feel overwhelmed.

The good news is you can learn how to manage debt and start afresh by following the steps below.

  • Get control of your spending to have more available cash to pay down your debts.
  • Stop making new purchases with credit cards to limit your exposure to further debt.
  • Get a second job/ side hustle. If you have another source of income, then you can use that extra cash to pay down your debt faster.
  • Pay off high-interest debt first. This will save you the most money in interest payments and decrease your total debt amount faster.
  • Make extra payments on your debt each month—to reduce the time it takes to pay off your debt and save you money in interest charges.
  • Consider debt consolidation. Consolidating all your debts into one monthly payment may get you lower interest rates and payments and give you more time to pay off your debt.

How Can Earnin Help?

Avoiding debt can be difficult but not impossible. Once you learn to navigate the world of finances responsibly and set your financial goals right, you can be well on your way to having a healthy financial future.

Earnin puts you in the driver's seat, giving you early access to your hard-earned wages through our Earned Wage Access tool (Cash Out)—so you can have cash on hand when you need it.

Our Financial Calendar feature also helps you keep track of bills and expenses so you can transfer out what you need when the time comes. What's more, you can save money through our Tip Yourself feature—which lets you reward yourself for reaching certain goals!

So download the Earnin app today and start taking control of your finances!

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