Maintaining a line of credit is a necessity for most people. Without car loans or mortgages, you won’t be able to build a good credit score and achieve milestones in life. However, research shows that nearly 71 million Americans with credit have mounting levels of debt in collections.
This shocking statistic stems from the lack of basic financial literacy among young adults. Bad money management can result in huge credit card bills and wreak havoc on your finances. Here are some of the biggest financial mistakes that can lead to debt.
Picking up a latte on your way to work may not seem like a significant expense but they tend to add up over time. Studies show that brewing your own coffee can save you a little over $60 each week. One of the biggest financial mistakes people make is spending too much money on little things that can result in debt over time.
In order to avoid frivolous spending, it is important to stay mindful every time you buy something. Take a look at the recurring expenses in your life and decide if you want to cut them out completely or look for cheaper alternatives. This can help you avoid debt in the long run.
Paying Bills Late
There’s no doubt that we have numerous financial obligations to meet each month, so it can be easy to skip out on a bill payment every now and then. While missing a payment may not seem too bad at first, it can throw you into a vicious cycle of debt. Before you know it, you have mounting debt coupled with high-interest charges.
The best way to avoid missing bill payments is to set aside a portion of your income to pay these bills. Alternatively, many companies let you automate payments which ensures that you never forget to pay a bill on time again.
Filing Taxes Past The Deadline
When you don’t file your taxes on time, you automatically accrue a tax debt that is accompanied by penalties and interest charges every month. If you find yourself in such a situation, you can still file for a tax extension to buy yourself more time.
However, if you do find yourself in tax debt, the IRS offers numerous options to meet your tax obligations. These include a tax installment payment plan and even a reduction in your tax debt. It is recommended that you speak to a licensed professional to discuss your options for reducing debt.
Setting An Unrealistic Budget
The best way to avoid high levels of debt in the future is to create a budget and stick to it. A budget is like a financial plan that shows you where your money is going. Without a budget, it is difficult to understand how much money you have to save and spend. This lack of information can lead to large levels of debt.
However, it is essential that you set budget goals that you can achieve. Many people set unrealistic expectations and this can put your finances in a loop. Having good control over your money from a young age can result in debt-free life in the future. So make sure you maintain a practical budget and start tracking your spending as soon as you enter the workforce.
Not Maintaining A Good Credit Score
Your credit score is an important number that determines your eligibility to secure funding for a home or a car. Most people don’t think about their credit score until they need to take out a loan and it might be too late. Moreover, when you do get the money with a low credit score, it usually comes with a high-interest rate attached.
Hence, you need to build your credit score early on. You can start with a single credit card and make sure to make timely payments on the balance each month. This can help you maintain a good credit score and save you millions on loans in the future.
In today’s digital age, everything we need is available at the tips of our fingers. However, it is important to remember that this efficiency comes at a cost. Many direct-to-consumer brands like Spotify and Blue Apron offer subscription services at a small fee each month.
While the monthly payments don’t seem like much, they can take out a substantial amount of your income over the course of a year. A great way to avoid unnecessary debt in the future is to cancel subscriptions that you no longer need or use.
No Emergency Fund
One of the biggest ways people go into debt is by not maintaining an emergency fund. This is an amount of cash that you set aside each month for emergencies. As a rule of thumb, you need to have at least three to six months’ worth of living expenses in your fund at all times.
If you are faced with an unexpected expense and don’t have an emergency fund, you will need to rely on credit cards or loans which can lead to mounting levels of debt. While it can seem challenging to put away a portion of your paycheck each month, it can result in large financial benefits in the long-term.
Living Beyond Your Means
In order to truly stay out of debt, you need to learn how to live below your means. This means understanding exactly how much money you have to spend each month and learning to spend less than this — in other words, frugal living.
When you spend everything you earn, any unexpected expenses will only lead to debt. So spending less than what you have will not only increase your savings but also ensure a debt-free life. Have a plan of action for your income each month. You can even create a monthly target for your expenses so that you have something to work toward.
Become Dependent On Credit Cards
Maintaining a credit line is a good thing as it helps increase your credit score and secure financing in the future. However, credit cards can also draw you into a debt spiral if they are misused.
For many people, a credit card is an easy way to afford things that you can’t afford right now. However, if you fail to pay the bill at the end of the month, it can only result in debt and interest charges. As a rule of thumb, you should only use your credit card if you are fairly certain that you can pay them off at the end of the month. Alternatively, you can also reduce your credit limit to avoid incurring too much debt.
Missed Investment Opportunities
One of the best ways to build long-term wealth is to invest your money. Putting your money into a retirement account is a good start but at the end of the day, you need to make your money work for you. This can be done by investing in stocks, index funds or mutual funds.
Many times, we often look at investment opportunities with a ‘glass half empty’ mentality. But if you invest passively and wait for better market conditions it can only result in missed investment opportunities. Every investment comes with an element of risk attached but it is important to stay proactive and remember that there is no risk without reward.
Focusing On Smaller Debts First
The best way to remain debt-free is to keep your credit levels under control. This means paying off your debts as soon as possible. When tackling your debts, it is best to focus on the most severe ones first. Many people make the mistake of paying off the smaller debts first since this is easier.
However, taking care of the larger debts like credit card bills or student loans can also reduce the amount of interest you need to pay and result in greater financial freedom. This type of debt repayment is referred to as the avalanche method.
Not Discussing Finances With Your Partner
As a young couple, it can be hard to discuss finances with your significant other but it is a necessity as it ensures you are both on the same financial page. Not discussing your finances is one of the leading causes of debt. When you discuss matters concerning money with your partner it helps you understand your current financial situation as you plan for the future.
In fact, research shows that couples who discussed finances with each other were happier in their relationships. Having open, honest conversations about your finances makes it easier to achieve those milestones together.
Not Having A Plan Of Action
In order to lead a debt-free life, you need to have a debt repayment plan. Although your credit card bill requires a minimum payment each month, this doesn’t mean that you can’t make higher payments on the balance to get out of the red faster.
A debt repayment plan includes an overview of all your current debts along with the interest rate for each. You can then pay off the debt using a snowball or avalanche method. Many financial advisors recommend that you tackle the larger debts first so that you have greater peace of mind.
Always Paying Full Price
In today’s day and age, you never have to pay full price for anything. Moreover, many websites like Groupon and Retail Me Not offer coupons for various stores. Alternatively, you can also visit a thrift store or peruse Craigslist to find some great deals.
And these deals aren’t just for things. Various apps offer deals and discounts on restaurant meals as well. With the right discounts, you can even save up to 30 percent on your total bill. Looking for ways to cut down your expenses this way can prevent the accumulation of debt in the future.
Buying A Home You Can’t Afford
Buying a home is an important milestone in your life and can help you put down some roots. However, many people look at home-buying as an item to check off their list rather than a financial investment.
An investment in real estate also comes with a huge price tag so you need to be absolutely sure of your finances before you take this major leap. Failure to meet your monthly mortgage payments can lead to mounting levels of debt. Moreover, if you might switch jobs and need to move to a new location, owning a home may not be the right financial choice for you.
Keeping Up With The Joneses
We see a new trend or a must-have product on the market every day. While we don’t always need the latest things, our ‘fear of missing out’ mentality makes us feel like we need to have them. This is often referred to as ‘keeping up with the Joneses,’ where we are under pressure from our peers to buy things we can’t necessarily afford.
A great way to control your spending is to use the 50/30/20 rule. This is where you spend 50 percent of your income on necessities, 30 percent on wants and 20 percent goes in savings. This way you will be more motivated to spend money on things you need and not give in to the hype.
Skipping Student Loan Payments
Many recent grads are burdened by student loans and on an entry-level salary and it can be hard to make a monthly payment towards this balance. However, defaulting on your student loan is one of the biggest mistakes you can make as it results in large amounts of debt and high-interest charges.
If you find yourself falling back on interest payments, speak to your financial advisor immediately. They can assist you with the best plan of action to make your payments on time. Failure to pay your student debt can lower your credit score and makes it harder to secure a loan in the future.
Closing Accounts Once The Balance Is Paid Off
Once credit card balances are paid off, many people choose to close their accounts but this is one of the biggest mistakes you can make. This is because your credit score depends on your credit history and the amount of time that you maintain a line of credit. Once you pay off your credit card bills, the credit limit increases.
A good credit score makes it easier to secure financing in the future to buy a car or a home. So closing your account once a balance is paid off will only hurt this score. Once you have cleared the balance on the account, you can lower your credit limit and pay off the monthly balance on time.
Having too many credit cards
Credit card offers can be tempting as they often come with reward points or travel miles when you spend money. While receiving these rewards can be exciting at first, this is precisely how people fall into debt as they are unable to pay back the credit balance. Moreover, if you have more than 3 cards, it is difficult to keep track of all the balances you need to pay.
The best way to avoid a situation like this is not to have too many credit cards. Alternatively, if you have more than 3 cards don’t use all of them at once. Maintaining a single card makes it easier to pay off the balance each month along with a good credit score.
Not Saving For Retirement
Many people use their mounting expenses as an excuse to not to save for retirement. But even if you have a mortgage to pay and debt obligations to meet, you still need to put away a portion of your income into a retirement savings account. You can look at this as a fixed expense as it helps you financially in the long-term.
If your company has a 401K account, be sure to take advantage of this, especially if there is a matching program. Alternatively, you can put your money in an IRA Roth account as well. Although this can eat into your income each month, saving for your retirement can make you more financially independent in the future.