July 31st, 2014

Don’t fall prey to debt


At any stage in life, this four-letter called DEBT can be a source of great distress and anxiety and can wreak havoc on people’s lives. Simply put, debt is a financial obligation or commitment owed to others. Many individuals use debt as a method for making large purchases that they could not afford under normal circumstances. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest.

Inconspicuous in meaning, debt can have a profound negative or positive impact on our lives. For many people, debt is something that creeps up on them, building slowly over time. Your debt may have grown from being small and manageable into something that now feels like it’s totally out of your control, but now you need to accept that your debt is a problem.

So what are the debt danger signals? You continually go over your spending limit or you use your credit cards as a necessity rather than a convenience; you are always borrowing money to make it from one payday to the next; your wages have been garnisheed to pay for outstanding debts; you pay only interest or service charges monthly and do not reduce your total debt over many months or creditors pressure you for payment, threaten to hire a collection agency to recover the money for them.

Your debt may have grown from being small and manageable into something that now feels like it’s totally out of your control, but now you need to accept that your debt is a problem. Struggling with debt is one of life’s most stressful experiences, however by managing personal debt, many of the pitfalls associated with debt can be eliminated.

It is important to understand that incurring personal debt is not inherently wrong. In fact, debt can be incurred for good reasons as well as
bad. In general, good debt will have a high probability of creating future economic value for the individual with a low probability of impairing his short-term financial condition.  In short, good debt creates valuable or productive personal assets without placing excessive strain on an individual’s income.  Mortgages and student loans are examples of good personal debt to the extent that the loan payments can be realistically serviced from the individual’s current or future earnings.

Bad debt however is debt that is unlikely to yield any future economic value to an individual and/or that is likely to contribute to worsening his financial condition.   Incurring debt in order to finance non-productive assets (a big-screen TV, for instance) or discretionary expenditure is a sure-fire sign of poor financial planning. This is usually exemplified by retail use of credit cards or by hire purchase acquisitions of some household items.  That said, even the acquisition of productive assets (a student loan, for example) via debt can prove to be damaging to the individual when the loan payments cannot be realistically serviced from the individual’s expected earnings.

Understanding what differentiates good debt from bad debt is of critical importance in making one’s financial plans. The fallout from impulsive decision making on personal debt can be very painful and can endure for many years.  Consequently, the decision to incur new debt must be critically evaluated at every juncture of your life.

If you currently have a debt problem or if you are committed to maintaining a healthy financial condition, the following debt management guidelines may prove helpful.

How much do you owe?

In order to manage debt you must first know what you owe and to whom it is owed. A simple list that itemizes how much each creditor is owed and their corresponding interest rate is usually the first step toward lightening your debt load.

Debt repayment

With the list competed, one should target the repayment of the debt with the highest interest rate first. More often than not, this is the credit card debt.  In working toward paying off credit card debt you should avoid falling into the minimum payment trap. Minimum payments might be low but they extend the term of the outstanding credit and ultimately cause you to pay much more interest. Additionally, some loan agreements carry variable interest rates which can change periodically. It is advisable to be vigilant to find out when and by how much interest rates change.

Accelerate debt reduction 

It is possible to accelerate debt reduction by prepaying installments.  However, when you make a prepayment on some type of debt (that is, pay more than what is immediately due), you should ensure that the extra payment goes to principal only. This serves to reduce the total amount owed as well as lowering interest that will accrue going forward. Making prepayments wherever possible is generally
advised, since in most cases speeding up the debt repayment period usually leads to less overall interest payments over time.  As soon as you have paid your first debt off, you get to work on the next debt and continue until you have cleared them all. Psychologically, it can be rewarding to see your creditors become fewer and fewer.

Negotiate with creditors

Depending on the nature of debt and condition of the debtor, it is worthwhile to consider re-negotiating terms with creditors. You may argue for a refinancing of credit card debt, having the interest rates reduced or repayment periods adjusted. Each of these can bring some short term relief to your debt burden. Renegotiation is a useful strategy particularly in periods of falling interest rates. If you’ve been a good customer in the past, the lending party may extend some goodwill toward your situation. However, you need to be wary of fees associated with debt restructuring as these may cancel off the benefits of the renegotiated terms.

Budget wisely

Ultimately, the best way to manage debt is to avoid it. If you want to get your debt under control, start by figuring out your spending patterns and identifying unnecessary expenses. Only through budgeting can an individual have a firm understanding of his or her sources of funds and take control of their financial situation. For many people, reining in discretionary spending for a few months goes a long way toward tackling debt. If you saddled with debt problems, then doing a budget is central. You have to get a handle on what you spend to future-proof your

Starting a budget could mean simply allocating your income between savings and different categories of expenditure.  One should keep a record of all spending so that the accuracy of your budgeting can improve over time. Try to set aside some of your salary each month so you have an emergency fund to fall back on should something unexpected happen in the future.

Establishing and sticking to a budget leads to financial discipline as well as a more prudent assessment of needs versus wants – and enhanced savings, which is the bedrock upon which long term wealth and peace of mind is built.