Step 7 - Avoiding Future Debt

So far this series of articles has covered how to get out of debt. The remainder of the series will teach you how to stay out of debt, stop living paycheck to paycheck and how to start saving and investing for retirement. If you are still working on paying off your debt, feel free to read ahead because these are principals that can help you now, but I also recommend book-marking this page or printing it for future reference.

In this section we will be looking at how to stay out of debt. The easiest way to learn how to stay out of debt is to look at how you got into debt to begin with. For most of us it falls into one of two categories, or possibly both. The first category is by being impatient and spending too much. This is a real problem, especially with the current generation. We think we should have now what our parents worked 50 years to get. Easy access to credit cards has helped fuel this problem. Most of us get our first credit card around college age, when we're least prepared to handle them, and get into a habit of spending about 20% more than we earn each year. Quite often, we end up having to pay off items we no longer use or even own.

The second category is by unforeseen or unplanned-for circumstances. Sometimes, we use credit to fund a wedding, buy Christmas presents or other major events that we know were coming, but failed to plan for. Other times, it's unforeseen circumstances, such as a having to replace a household appliance or a car needing repairs. Regardless of the cause, there are steps you can take to protect yourself so you don't have to go into debt to cover them.

If your problem is the first category, my advice to you is simply quit it. If you see something you absolutely have to have, you can take the time to save up for it, instead of purchasing it on credit. You may think the second cause is unavoidable, but there is really a very simple solution: save up a safety buffer for unforeseen circumstances.

Most of us live paycheck to paycheck and anything at all going wrong that costs us some extra money can cause stress, panic and sometimes means that we'll be eating nothing but Ramen noodles for a few weeks. Having this extra savings buffer will help eliminate this stress and help you live a more stable lifestyle.

I recommend saving about $1,000 - $2,000 to begin with, and I also recommend placing it in a separate savings account, so you won't be tempted to spend it except for in emergencies. You want to be sure to keep this money in a savings account rather than investing it; that part will come later. If you were to place this money in a CD, you wouldn't be able to access it at the time of an emergency without taking a penalty on it. If you put it in another type of investment such as a mutual fund, the price may have fluctuated down to where it's now a bad time to sell your shares, at the very time you need the money, causing you to lose money on the investment. There may also be a waiting period for getting to this type of invested money. This buffer is for emergency use, and you need immediate access to the funds.

In addition to this emergency fund, you need to save for major purchases such as a car. If your current car is paid off and you're not actively making payments toward your other debts anymore, open a separate savings account and begin “making your car payment” into these savings accounts. If you do this for several years then when it's time to buy a car, you can take money out of this account to pay cash for it or at minimum, make a decent down-payment.

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