By Michael Feng. Edited by Arjun Chandrasekar.
Historians believe the creation of writing was to document financial transactions and debt, dating back several centuries. So if recording financial transactions was so important that it was necessary to invent writing, we should learn to manage our finances! Today, we’ll be examining one specific aspect of personal finance: debt, a term often associated with negativity. However, this isn’t necessarily always the case, and in this article, we’ll examine the different types of debt and how you can manage each type. There are three main types of debt being: debt from loans, debt from circumstance, and debt from spending.
Debt from Loans
The first type of debt that we’ll be talking about is something many are familiar with: loan debt. Loan debt can come in the form of a mortgage, student loan debt, or an auto loan to buy a car. While interest rates on these types of debts are lower than interest rates on something like a credit card, loans usually take up a considerable portion of your income, making them something you want to manage in order to cover all your other expenses.
Debt from Circumstances
The second type of debt can almost always be avoided, and should be at all costs. Debt from circumstance begins in occurrences you cannot control. For example, you may have a sudden injury, requiring medical bills you’re incapable of affording. If you get into a lot of debt, being unable to fully pay it off causes even more debt, resulting in an endless cycle of debt that can sometimes be unmanageable.
Debt from Spending
Last but not least, debt from spending. This type of debt should not happen at all if you budget correctly. Almost always, debt from spending occurs from overspending with credit cards, where banks charge high percentages of interest. This is rather self-explanatory, but very important to mention as the statistics of credit-card debt are very alarming. The average credit card debt per U.S. adult with a credit card is $4,600 and Americans’ outstanding revolving debt, most of which is credit card debt, reached $980.4 billion in the first quarter of 2021.
The Path to end Debt
Now for those of you not in debt, first of all, congrats! However, it’s always best to be proactive than reactive, so here are some steps you can take to reduce your likelihood of falling into debt. The first thing, if you haven’t done so already, is to create an emergency fund. If your budget is tight, even a few hundred dollars will work, but here’s a comprehensive guide on how emergency funds work. Another tip is to first separate your spending into mandatory expenses and discretionary expenses. Mandatory expenses are expenses like utilities, food, rent, etc. Discretionary expenses are things like a Netflix subscription, eating out, or any memberships. Next, attempt to minimize your discretionary expenses, and finally, create a budget. In a nutshell, list all your expenses and your income, and, no matter what, ensure that your income is greater than all your expenses.
For those of you in debt, this is not necessarily a terrible thing. If you’ve invested in your future with student loan debt or took out a mortgage, these are all manageable and by creating a budget, you will be able to guarantee financial safety. While things may get difficult if you get into credit card debt or any other form of high-interest debt, one good plan out of money is debt stacking. Debt stacking is where you sort the interest rates of all of your debt, and make the minimum payment on all of your debt while paying off as much debt as possible into your highest interest rate debt. This strategy is derived from the idea that the longer time goes on, your debt with the higher interest rate will increase the most, hence the idea to pay off that debt in the beginning.
Ultimately, getting out of debt or preventing it may seem daunting, but by understanding the different types of debt and by creating an emergency fund, a budget, and a plan to get out of debt if in debt, you’ll be fine!