4 Money Mistakes That Could Send You Spiraling Into Debt
by Kailey Hagen | Updated July 17, 2021 - First published on Nov. 3, 2019
Emergencies happen. Don't make them worse by making one of these money mistakes.
Almost everyone carries debt at some point in their life. That isn't always a bad thing.
Debt you plan for, like a mortgage or car payment, can help you finance large purchases and improve your credit score if you keep up with your payments.
But debt you don't plan for, like overspending on your want list or covering a trip to the emergency room, can be a source of stress, blame, and lost sleep.
Here are five mistakes you can't afford to make if you want to avoid these debt problems.
1. Not having an emergency fund
An emergency fund is money you keep on hand to cover unplanned expenses like medical emergencies, insurance deductibles, or living expenses after a job loss. It should contain at least three months of living expenses -- six months is even better, if you can manage it.
Without an emergency fund, you may have to charge these expenses to a credit card or fall behind on some of your other bills.
Start an emergency fund today if you don't already have one. Decide how much you can afford to set aside from each paycheck and keep saving until you meet your goal. Always replenish your emergency fund after you take money from it and reevaluate your fund at least once per year. If your income or family size changes, determine whether you need to save more.
2. Not sticking to a budget
Next to having an emergency fund, creating and sticking to a budget is the best thing you can do to keep yourself out of debt. List all your monthly expenses and subtract them from your monthly income. If you're spending more than you earn, you might have to cut back on discretionary purchases to make ends meet. If you have a little money left over, put it toward retirement or another one of your long-term goals, like a down payment on a home.
The best budget is the one you can stick to. If you ignore it, there's no point in having it. But at the same time, you have to be reasonable about how you spend your money. Basic living expenses, like rent or mortgage payments and food, should be your top priority, followed by savings for long-term goals, followed by discretionary spending.
Sometimes you may have to make difficult calls. Dining out is technically spending money on food, but it's more expensive than cooking at home, so it's discretionary spending.
Use a budgeting app if you struggle to track your spending and revisit your budget at least once per month to make sure you're sticking to it. If not, look for what went wrong and decide how you'll prevent it from happening again.
3. Charging more to your credit cards than you can pay back
Credit card debt is one of the worst types of debt; its interest rates can exceed 30%. That can cause your balance to swell quickly. Credit card debt also raises your credit utilization ratio -- the ratio of the credit you use each month to the credit you have available -- and this can hurt your credit score.
It's fine to use your credit cards for purchases, especially if you're earning rewards, but keep track of how much you charge. Don't spend more than you know you can pay back at the end of the month. You should also try to spend 30% or less of your available credit each month.
If you already have credit card debt, use most of your extra cash each month for debt repayment. You could also transfer your balance to a card with a 0% introductory APR or take out a personal loan to cover the debt. These loans have high interest rates as well, but at least you won't have to worry about your balance growing any further.
4. Not having adequate insurance
Health, auto, and homeowners or renters insurance can be expensive, but can end up saving you tens or hundreds of thousands of dollars if you need to file a claim. Having no or inadequate insurance can cost you thousands out of pocket. Your emergency fund might not even cover it.
Go through your insurance policies and make sure you have adequate coverage. Consult an insurance agent if you're unsure how much coverage you need.
If you have a family to support, consider buying a life insurance policy to keep them from falling into debt if you die unexpectedly. These policies are usually at their cheapest when you're young, so don't wait to purchase one.
Even when following the above tips, you'll probably still have to take on debt at some point, but hopefully, it'll be debt that you planned for and can pay back comfortably. Unexpected expenses will still arise, but if you avoid the above mistakes, you'll be more prepared for them.
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