There are a number of reasons why so many Australians are stuck in a revolving debt cycle so let’s look at five common reasons why this happens.
1. You only make minimum credit card repayments
If you only make minimum payments on your credit card each month, then you’re never actually paying off any of the principal.
In fact, your debt can actually become unmanageable if your balance continues to grow while you’re paying the minimum amount required.
Look at it this way…imagine you have a $5,000 debt on a credit card that attracts an interest rate of 17 per cent and you only make a minimum monthly payment of, say, three per cent of your balance.
Guess how long it will take to pay off that $5,000 debt?
It will take some 189 months — or nearly 14 years — to pay it off while also accruing interest of nearly the same amount as the principal.
So a simple strategy is to increase the amount you pay each month, which can make a big difference to how long it takes to pay off.
Ideally, you should pay off your credit card balance every month.
If you can’t do that, then your spending is likely far exceeding your income and you shouldn’t be buying on your credit card in the first place.
Too many people see the available balance on their credit cards as their money – and it isn’t!
2. You splurge on holidays
This particularly happens around Christmas time when many people rely on credit to cover their holiday spending, which means that they start the New Year in worse financial shape than they ended the previous year.
Sometimes it’s because you feel like you have to “keep up with the Jones”, but it’s quite possible your friends are also in credit card debt and struggling.
A good strategy to consider is to avoid spending time around others who have a tendency to overspend and stop getting yourself into situations where you might be melting the plastic at the register.
Maybe you should consider locking up the credit cards at this time of year and holiday within your financial means instead.
3. You believe that debt is part of life
One of the biggest reasons people get stuck in debt is because they believe that debt is just a normal part of life.
However, the type of bad debt I’m talking about is a result of wanting or needing something that you don’t actually have the cash to buy at the moment.
And the problem is you go to the ATM and borrow next month’s money today and pay a premium to do so.
Now that’s a bad habit.
Maybe you need to give yourself a wake-up call by keeping close tabs on your spending to see how much you’re relying on debt to maintain your lifestyle.
Once you work out how much you owe, make a plan to pay off the debt, because having a goal of getting out of debt might give you the motivation you need to stop relying on it.
4. You don’t have a “rainy day” fund
I always recommend that people set aside money for a rainy day such as those unexpected medical expenses, repairs or a job loss.
The amount of this contingency fund will vary depending on what your regular expenses are, but a good guideline is to have enough funds to financially sustain you and your family for up to six months.
Too many people, however, don’t have any cash reserves at all so rely on credit cards when these unexpected expenses crop up.
But doing this means they’ll end up paying more than the original cost of the emergency if they don’t pay off the balance quickly because of the high interest attached to credit cards.
5. You allow expenses to rise with income
There is a well-known saying that people’s expenses usually rise up to match their income.
So, if they’re the happy recipient of a pay rise or get a new higher paying job, their expenses increase to match because they believe they can “afford” a nicer car or more expensive clothes.
This can be especially dangerous if they’re still carrying debt from the days when they were earning less and are now taking on more loans to help pay for that bigger house or better car.
Their debt will simply balloon, leaving them unable to pay it off – despite the bigger pay cheque.
The bottom line…
Debt doesn’t have to be a dirty word but you must have the financial discipline to manage it correctly.
This includes creating and sticking to a budget to ensure that you live within (or preferably below) your means – all of the time.
If you’re forever splashing out on things you don’t really need and paying for them on credit with money you don’t really have, it’s likely that you’ll never find a way out of the vicious bad debt cycle.