Can you really turn your financial life around? If you are like most people, your…
What is Debt?
Debt is an obligation that requires one party (the debtor) to pay money or other agreed-upon value to another party (the creditor). Debt may impact your journey to financial freedom because it increases your liability and therefore, reduces your net worth. In addition, debts can result in bad credit scores. However, not all debts are bad; there are good and bad debts.
Good Debt and Bad Debt
A good debt is money you borrowed to build wealth or increase your net worth over time. Examples are, money borrowed to expand a growing business, mortgage loan for a house in which some rooms will be rented to cover the mortgage payment, money to purchase land to be leased out to farmers, student loan (This loan gives you the necessary skills needed to make more money), etc.
On the other hand, bad debt is money you borrowed to pay for things that won’t improve your net worth, such as credit card debt, store card balances, car loans, going into debt for things that have no lasting value such an expensive vacation, a fancy dinner, clothing and electronic gadgets.
A key principle for financial freedom is to use good debts to increase your net worth and stay away from bad debts.
Managing debt responsibly will increase your net worth. There are usually four types of borrowers. If you are currently in debt, figure out where you fall in:
- This group lives in a fantasy world. They are in competition with others and therefore, borrow to meet up. They focus on monthly payments on debts and not on their overall debt.
- This group tends to purchase things to help them feel better, to relieve stress, or to escape their problems.
- This group lives on instant gratification. When they see something, they want (not needed), they must get it.
- This group knows the pitfalls of borrowing and finds ways to avoid the wishing, wasting, and wanting syndromes.
How to Pay Off Debts
First, accept that owing debts, especially bad debts, may affect your journey to financial freedom. Make it a point of duty to either avoid any debt or pay off debts immediately. Here are some tips to paying off your debts:
- Increase your income: Make extra money to pay off your debts.
- Pay Cash for Goods: Avoid buying things with credit cards. Psychologists say it’s more difficult to let go of cash, however, it is easier to swipe a card.
- Live on a budget: Have a monthly budget and stick to it. Form the discipline not to spend on anything outside your budget no matter how appealing it is.
- Pay off your most expensive debts first. Here, I don’t mean the largest debts in amount, rather I mean the debts that have the most negative impacts on your life. In this group are debts that may lead to incarceration, debts that accumulate the highest interests, debts that may destroy your marriage, debts that may make you lose your job. Don’t let debts ruin your life and relationships.
Protecting Your Credit
Protecting your credit is an important step to financial freedom. Good credit and low debt are key factors in achieving financial freedom. A good credit score can be useful in renting an apartment, getting a high-paying job, and buying a house. It opens doors. How you handle your credit affects your debt profile and will affect your net worth many years from now. An important aspect of your credit is managing your FICO score (credit score), which affects the interest rates of your loans. Use the following tips to manage your credit responsibly:
- Keep your Personal Identification Numbers (PIN) to your ATM Cards, Credit Cards and accounts secure and don’t share with anyone.
- Always check your bills and pay off the balance in full each month before the due date. Don’t just pay the minimum payment due. That way, you avoid late payment penalties.
- Avoid either getting large credit limits, taking cash withdrawals or credit card cheques.
- If you want to build credit history fast, only use your credit card to buy goods you have the cash to pay off immediately, then use the cash to pay off the balance right away to avoid interests and late fees.