Dealing with debt can be a stressful and challenging experience, but there are several steps you can take to manage your debt and work towards becoming debt-free:
- Create a budget: Start by creating a detailed budget that includes all of your income and expenses. This will help you understand where your money is going and identify areas where you can cut back.
- Prioritize your debts: Make a list of all your debts and prioritize them by interest rate and/or amount owed. Consider focusing on paying off high-interest debts first to minimize the amount of interest you are paying.
- Negotiate with creditors: If you are struggling to make your payments, consider negotiating with your creditors to see if you can work out a payment plan or reduce your interest rates.
- Consider consolidation: Debt consolidation can be an effective way to simplify your debts by combining multiple debts into a single loan with a lower interest rate. This can help you save money on interest and reduce your monthly payments.
- Seek help if needed: If you are feeling overwhelmed by your debt, consider seeking help from a credit counseling agency or financial advisor. They can provide you with guidance and support to help you manage your debt and improve your financial situation.
Remember that dealing with debt takes time and effort, but with a clear plan and determination, you can take control of your finances and become debt-free.
Classes of Debt
Not all loans are bad.
There is good debt and bad debt. Good debt is where the money borrowed is used to finance things that will increase in value in the future. These include student loans and house mortgages.
On the other hand, Bad debt, is where the borrowed money is used to finance things that will decrease in value in the future. These include consumables and most of the material things.
Good debt is only good to take as long as its future returns will exceed the total cost of taking the loan. If it doesn’t, it qualifies to be bad debt. The debt that kills our financial goals is bad debt.
Where Does Debt Come From?
Living Above Your Means
Loans allow us to quickly afford things that would take months or years of savings for us to afford them. Companies are using our greed to make profits. They are making our desires easy to satisfy.
“many people are buying things they cannot afford with money they do not have to impress people they do not like.”
Lack of Proper Budgeting
Most of the emergency loans that people take are a result of poor budgeting. When you do not tell your money where it should go through budgeting, you will always end up wondering where your money went. When you fail to allocate enough money to your most pressing needs, you will end up borrowing.
Moreover, when you cannot spread your money to cater to your needs until the end of the month when you receive your salary, the debt business is proud of people like you.
You are helping them make money as they will readily give you a loan to push you to the end of the month.
Poor Spending Habits
Michael Johnson writes, “A poor man knows the true value of money and will not dare waste it. But a rich man is extravagant and always looking for an opportunity to empty his pockets.”
As humans, we are often slaves to our desires. Unfortunately, money is a limited resource and has to be used wisely. You cannot satisfy all your wants at a go. You must learn to prioritize the most important ones and give yourself time to save up for any life upgrades.
Disadvantages of Debt
Stress & Depression
Debt is among the leading causes of stress, depression, and even suicide. When you have a huge debt to clear, you hardly sleep at night. You are worried about losing your collateral or even not raising money to clear the loan.
Instant Gratification
Debt gives you the false emotional high of getting new things without having to deal with the pain of getting the money first. In the real sense, you are selling short-term desires at the expense of your future financial success.
Every shilling you borrow today is two shillings taken away from your future income. Debt borrows from the future income that you hope to earn. You are winning in the short term to lose in the long term.
Delayed Financial Goals
Debt delays you from reaching your financial goals. Every month you have to cut a certain amount of your income to clear the debt. The money could have otherwise made it to your savings or investments. Moreover, the cost of borrowing money is high. You end up paying more when you take a loan instead of saving up money.
Important questions to consider before taking a loan.
1. Can I accumulate savings to buy this thing instead of taking this loan?
2. Will I have something to show for this loan in the next five years?
3. What other alternatives do I have to pay for this?
Why are loans bad?
Look at the charges for taking a salary advance personal loan in one of the largest banks in Kenya.
Interest – 11% – 13%
Processing fees – 5%
Insurance fees – 0.63%
Late fees – 5%
Other fees – 20% excise duty
Others even charge a negotiation fee of 2.5%
How To Avoid Debt
Create An Emergency Fund
Most of the debt is taken during times of financial crisis. This is when an emergency comes up and you do not have spare money to cater for the unexpected expenditure.
Having an emergency fund to cover your daily expenses for at least 6 months will help you in such scenarios. When a financial crisis looms, you will have a backup plan instead of clinging to emergency loans.
Moreover, if you have only one source of income or you have other people depending on your income, it’s wise to increase the period that your emergency fund covers you. When you are walking to the desert, carrying more water will do you no harm.
Live Below Your Means
As a rule of thumb, if you cannot afford twice or thrice what you are buying, then you cannot afford it. Don’t take a loan to buy it. And true to Morgan Housel’s words,
“Spending money to show people how much money you have is the fastest way to have less money.”
Create A Budget That Works For You
Tell your money where to go. Allocate the most demanding needs the share they deserve and don’t forget to save. Unnecessary wants should be eliminated or reduced.
Should You Invest Borrowed Money?
Investing with borrowed money only makes financial sense when the investment being made has low risk and the expected return on investment is high.
Taking a loan to invest in stocks would be exposing you to a lot of risks. As Nick Maggiulli writes, Don’t borrow money and then invest it. And if you do, keep it to a minimum.”
Furthermore, the investment should mature before the loan is due so that you can use the returns to repay your loan.
How To Get Out Of Debt
Getting out of debt requires proper planning. You first have to determine the total debt you owe, to whom you should pay, when you should pay, and how much is the minimum amount you should pay every month.
With this information, come up with a plan to clear the debt as fast as possible. Try to unlock money from other unnecessary expenses so that you can clear the loan. Cut down on your spending habits and save as much as you can. Instead of just paying the minimum required contribution, add any amount that you can. This will help you reduce the total cost of the loan as you will reduce the total interest accrued.
Sometimes Loans Are Our Only Way Out
Loans were created for a reason. Sometimes, even with our upbeat financial knowledge, life happens and you find yourself in a financial crisis where your only way out is through borrowing money.
Whenever this happens, try to negotiate for lower rates, or borrow from institutions like SACCOs that offer friendly loans. Otherwise, try as much as possible to stay out of debt.