Debt is easy to accumulate, but if you’re not careful, you can end up in a debt trap that harms your credit score, financial security, and mental health.
The key to avoiding bad debt is to take control and manage your finances.
1. Don’t max out your credit limit
Simply because you have credit available doesn’t mean you have to use it all. Credit utilisation is a significant factor in calculating your credit score, and using more of your available credit lowers your score. You will also be paying a lot of interest, which increases your chances of defaulting.
Manage your debt by paying more than the minimum due each month and not incurring new debt until your accounts are settled.
2. Use cash and credit correctly
Pay all of your day-to-day living expenses in cash so that you will stay within your budget. Using credit for these expenses allows you to easily overspend because there are no immediate consequences. Only use credit for big-ticket items like a car or property, also known as “good debt.”
Learn the art of waiting and saving for specific goals. We live in an era of instant gratification, using credit to pay for clothes, home furnishings, entertainment, and even holidays. Without proper discipline, your debt can quickly snowball out of control.
3. Look beyond the monthly instalment amount
When considering new debt, don’t only consider the monthly repayment amount and whether you can afford it. If interest rates rise, your instalment amount will increase, or you may lose your income and be saddled with a huge debt that you cannot repay. Consider the total amount of new debt you are taking on and how this affects your financial health.
4. Avoid revolving credit
Store cards, credit cards, and revolving credit loans provide you with access to available credit as long as you make your monthly repayments on time. Bank overdrafts operate in a similar manner, allowing you to access available credit at any point.
This type of credit has no end date; all the creditor requires is that you service the debt. Often, too, your credit limit is increased if you manage the debt well, so you end up further in debt. It’s an endless cycle of repaying and borrowing, and you could find yourself caught in this debt trap for many years, eventually damaging your credit score if you default on your repayments.
5. Steer clear of balloon payments
Buying a car with a balloon repayment plan is a classic debt trap, so be aware of the full implications of this type of agreement. While it may seem like an affordable way to drive the car of your dreams, once the initial loan is paid off, there will still be an amount owed (usually a large sum) that will need to be settled in cash or refinanced. You will be in debt for a long time, and you run the risk of not being able to afford all your debt repayments.
6. Be wary of loyalty card rewards
Loyalty programmes offer great benefits, but be aware of the pitfalls. Earning loyalty points every time you use your credit card can accumulate quickly, but this may also tempt you to use your credit card for all your purchases.
If you settle your credit card balance in full each month, it can work to your advantage. However, you may be unable to do so, finding yourself slipping further into debt each month.
7. Keep track of your debts
Take control of your credit by having a full view of how much debt you have and then working to reduce the balances. Check your credit report regularly, and notify the credit bureau if there are errors in your score. Understand how your behaviour affects your credit score and maintain a healthy score. This will allow you to obtain credit at good rates, saving you money in the long run.
8. Acknowledge when you have a debt problem
If you are unable to pay your debts while also having enough money to live for the rest of the month, admit that you have a problem. You need to consider options such as arranging with your creditors to pay off a lower amount each month, a debt consolidation loan, or even debt review.
Don’t borrow from family or friends or take out payday loans, as you will fall deeper into debt. Rather, take the right steps before your accounts are in arrears and you face potential legal action.
Bad debt doesn’t happen by accident. Take ownership, make informed decisions, and manage your credit to avoid feeling helpless and overwhelmed by your debt.