Buzz
In my 20s, I cleared my student loans, and it was an amazing feeling. For the first time, I had discretionary income – money left after covering all my essential costs. Aside from splurging on unnecessary items, I had no idea what to do with that extra cash. If this sounds familiar, whether you’ve just paid off a car loan, student debt, or credit card balance, here are some steps you can take.
Formulate a Plan to Prevent Falling into Debt Again
Once you eliminate a major debt (or, even better, all of your debts), the last thing you want is to undo your hard work by falling back into debt. Unfortunately, many people do. To prevent this, take a moment to reflect on where your debt originated and how long it took to pay it off. Some types of debt are easier to fall back into than others. For instance, you’re probably less likely to accumulate student loan debt again than to rack up credit card debt.
Many people assume that debt happens because of a lack of self-control, but that's not always the case. Sometimes, debt comes from desperate situations. Maybe emergencies are the culprit. Every few months, something unexpected occurs: your car needs an alignment, your dog requires surgery, or even you need surgery. If emergencies constantly force you to put expenses on credit cards, focus on building an emergency fund. You don't have to save the traditional 3-6 months' worth of living expenses, either.
You can start with small steps and save just enough to prevent falling back into debt. Yes, you may still face emergency expenses, but being prepared for them puts you in a much stronger financial position and helps you avoid making desperate decisions.
Sometimes, it's regular expenses that catch you off guard. The holidays, for example, are a prime example. Many people end up in debt during the holiday season simply because they weren't ready for the costs. But these expenses aren't exactly a surprise. If the holidays tend to trigger debt for you, take action this year by saving early. Use an online budgeting tool to estimate your holiday costs, then put aside a set percentage each month to cover those expenses.
For some, though, problem spending is the actual issue. Ask yourself a few simple yet revealing questions about money that may seem trivial but can uncover some interesting attitudes and habits:
How did your parents manage their finances?
What was your perspective on money growing up?
How do you define “needs” and “wants”?
These are some introspective questions, I know, but they can reveal a lot about how you ended up in debt. For instance, my family struggled financially when I was younger, so I was drawn to the idea of spending money on whatever I wanted, whenever I wanted. While my student debt wasn’t a result of this, the credit card debt I accumulated definitely was. I soon realized that, if left unchecked, my impulsive spending could land me back in debt. There are also more practical triggers to consider, such as the ones mentioned by Daily Worth:
For example, do you find yourself giving in to friends' pressure to splurge on pricey dinners, vacations, or shopping binges, or do you hit the mall whenever you're feeling bored or down? Recognizing these habits and thought patterns, and then taking active steps to alter your behavior, can help you stay out of debt, according to Perez.
If impulsive spending is your trigger, you can create a set of rules to resist temptation and even punish yourself for splurging, like:
Removing your saved payment details to avoid the temptation to shop
Avoiding spending during weekdays to curb impulsive buys
Applying a “splurge tax” on yourself whenever you overspend
Ultimately, the key lies in focusing on more than just the trigger or your response, but on the space in between. To truly avoid falling back into debt, you can't simply focus on what sparks your spending and how you react once it's done. You need to work on resisting the urge to spend in the first place. Think of impulsive spending as the enemy of your financial ambitions (no financial goals yet? Don't worry, we'll address that).
Create a New Goal
If you've paid off a major debt but still have others left, it's clear that you should focus on those next. Choose a strategy like the Snowball (pay off the smallest debts first), Stack (focus on the highest interest rate debts), or the Blizzard (a mix of both). If you've already knocked out a large debt, chances are you're well on your way to eliminating the others. But what happens after that?
After clearing all my debt, I ended up buying a ton of stuff I didn't need. Hundreds of dollars worth of clothes I barely wore. Phone upgrades that weren't essential. A vintage ALF lunchbox I scored at a garage sale (which was cool, but not the smartest financial choice as it sat collecting dust in the back of my closet for years).
There’s an argument for the idea of 'it’s your money, spend it how you please,' but that wasn’t my case. I had no idea what I wanted. I knew saving was important, so I put away a standard amount into a generic 401(k), but beyond that, I was lost. Then I started thinking about what I could do and made a list of things I wanted, regardless of money: moving to a new place and taking a trip abroad. Suddenly, I had a purpose for my discretionary income: save for the trip and save for the move. My finances had a purpose again, and I stopped wasting money on meaningless stuff to put it toward goals that truly mattered to me.
You don’t need some grand, clichéd travel goal for your money, though. Your goal might simply be to save for your child’s education or to create a better life for your family. Whatever it is, setting a clear goal is the first step to organizing your finances. Once you know what you want, it’s time to adjust your budget to align with your goals.
There are also practical goals to focus on. For instance, if your emergency fund is just enough to get by, now is the time to strengthen it. Then there's retirement savings. The amount you need to save depends on various factors, like how much time you have until retirement and the lifestyle you envision. Fortunately, there are many online retirement calculators that can help determine how much you should be saving each month. Plug in your details and ensure you’re saving sufficiently.
If you don’t have any immediate goals like travel or saving for a home, but simply want to save more for the future, consider this savings pyramid as a basic guideline for prioritizing long-term savings. After building your emergency fund, maxing out your 401(k) match, and paying off debt, your next steps should be:
Open and contribute to an Individual Retirement Account (IRA)
Increase contributions to your 401(k)
Start a regular savings or taxable investment account
Of course, your situation may differ. For example, you may have an excellent, low-cost 401(k) and prefer to focus on increasing your savings there rather than opening an IRA right now—and that’s completely okay. These are just general recommendations for optimizing your long-term savings.
Keep an Eye on Your Finances Moving Forward
If you want to avoid falling back into debt and successfully achieve your financial goals, you need to monitor your money going forward. This means tracking your spending and ensuring you adhere to a budget.
That’s pretty straightforward, and it likely played a significant role in helping you get out of debt in the first place. However, it’s also important to keep an eye on your credit after clearing your debt. After all, you've shown that you're trustworthy by paying off your debts, so you want to make sure your credit score and report reflect that. There are a variety of ways to monitor your credit for free, but annualcreditreport.com is the best resource for obtaining a free copy of your credit report, which you are entitled to annually. So, what should you look for? A few things.
First, ensure that the accounts you’ve paid off show that they’ve been paid off. Your balances should read zero, and the status should reflect something like “current” or “paid as agreed.”
Second, it may take a few months, but your credit score should improve. Since payment history plays a significant role in your score, a positive one will lead to an increase over time. Another factor is credit utilization, which is the ratio of your available credit to the amount you actually use. After paying off a debt, if the account remains open (such as a credit card), you still have access to that credit but aren’t using it. This reduces your credit utilization, which in turn should raise your score.
Paying off your debt is a huge accomplishment! You’re now more in control of your finances, and to maintain that control, you should stay focused on your financial goals. Dedicate fifteen minutes daily to personal finance. Research the next step, whether it’s investing or saving for a home. The more you keep money management at the forefront, the more likely you are to stick to your plan and stay debt-free.
Illustration by Sam Woolley. Pictures: www.lifeofpix.com, skitterphoto.com, pixabay.com
