Escape the Debt Cycle

The Spiral that Burns
Photo: Ryan Etter / Getty Images

Debt is a double-edged sword: It can be useful when you invest in the future, but you eventually need to pay off debt so you can build net worth. When you’re unable to do that (for whatever reason), the result is a debt cycle that’s difficult or impossible to escape.

Borrowing is a way of life for many consumers. Mortgages and student loans, which are often considered “good debt,” can take up a substantial part of your monthly income. Add credit card debt and a new auto loan to the mix every few years, and you can easily get in over your head. Payday loans and other toxic borrowing are almost guaranteed to lead to a debt cycle.

What Is a Debt Cycle?

A debt cycle is continual borrowing that leads to increased debt, increasing costs, and eventual default. When you spend more than you bring in, you go into debt. At some point, the interest costs become a significant monthly expense, and your debt increases even more quickly. You might even take out loans to pay off existing loans or just to keep up with your required minimum payments.

Sometimes it makes sense to get a new loan that pays off existing debt. Debt consolidation can help you spend less on interest and simplify your finances. But when you need to get a loan just to keep up (or to fund your current consumption, rather than investing in your future via education and property), things start getting dicey.

How to Get Out of a Debt Trap

The first step to getting out of the debt cycle trap is acknowledging that you have too much debt. No judgment is necessary—the past is the past. Just take a realistic view of the situation so you can start taking action.

Even if you can afford all of your monthly debt payments, you’re trapping yourself in your current lifestyle by staying in debt. Quitting your job for the family, changing careers, retiring someday, or moving across the country without a job will be next to impossible if you need to service that debt. Once you recognize your need to get out of debt, start working on solutions:

Understand Your Finances

You need to know exactly where you stand. How much income do you bring in each month, and where does all of the money go? It’s essential to track all of your spending. So, do whatever it takes to make that happen. You only need to do this for a month or two to get good information. Some tips for tracking your expenses include:

  • Spend with a credit or debit card so that you get an electronic record of every transaction.
  • Carry a notepad and pen with you.
  • Keep (or make) a receipt for every expense.
  • Make an electronic list in a text document or spreadsheet.

Especially if you pay bills online, go through your bank statements and credit card bills for several months to make sure you include expenses that don't land every 30 days, such as quarterly or annual payments. Balance your account at least monthly so that you’re never caught by surprise.

Create a Spending Plan

Now that you know how much you can afford to spend (your income) and how much you’ve been spending, make a budget that you can live with. Start with all of your actual “needs” like housing and food. Then look at other expenses, and see what fits. Ideally, you’d budget for future goals and pay yourself first, but getting out of debt might be a more urgent priority. Unfortunately, this may be where you need to make some unpleasant changes. Look for ways to spend less on groceries, get rid of cable, get a cheaper cell phone plan, ride your bike to work, and more. This is the first step in living below your means.

Put Away the Credit Cards

Credit cards aren’t necessarily bad (in fact, they’re great if you pay them off every month), but they make it too easy to fall into a debt spiral. The high-interest rates on most cards mean you’ll pay a lot more for anything you buy, and paying the minimum is guaranteed to bring trouble. Do whatever it takes to stop using them—cut them up, put them in a bowl of water in the freezer, or whatever you need to do. If you like the convenience (and automatic tracking) of spending with plastic, use a debit card linked to your checking account or a prepaid debit card that doesn’t allow you to rack up debt.

Change Your Habits Little by Little

It’s great to get those “big wins” like downsizing your car or canceling expensive cable service. But small changes matter, too. Perhaps you grab lunch out with coworkers a few times a week, enjoy eating out on weekends, and love spending money on concerts and ball games. While these are not bad expenditures, they can wreck your budget if you're going into debt for them. If you’re serious about getting out of debt, you need to change your habits little by little. Start small by making your coffee at home and bringing your lunch to work, and go from there.

Cut Your Borrowing Costs

It’s risky to get additional loans, but one last one might be in order. If you’ve got credit card debt at high-interest rates, you might barely be covering the interest costs each month—even with a hefty payment. Consolidating debt with the right loan can help more of each dollar go toward debt reduction. But you need discipline—once you pay off debt (or, more precisely, move the debt), you can’t spend on those cards anymore. A credit card balance transfer is one way to get a cheap loan temporarily—just watch out for the end of the promotional period—and online lenders offer competitive rates on longer-term loans.

Pick Up a Part-Time Job

Depending on how much debt you’ve got, a part-time job or side hustle may be in order. Mowing lawns, pet-sitting on the weekends, driving for a ride-share company or making deliveries, or other gigs in the sharing economy are all good choices. Overtime at your current job will help, especially at time-and-a-half pay. Any additional money you make can be put toward your debt to help accelerate your payments.

Avoiding the Debt Cycle

Avoiding debt in the first place is easier than digging yourself out of a hole. Once you’re on solid financial ground, stay disciplined. With advertisements thrown at you everywhere from the radio to your Instagram feed, plus the pressure of “keeping up with the Joneses,” avoiding debt is not easy.

Live Below Your Means

Just because you can afford it, that doesn’t mean it’s the right choice. Purchase a house you can easily afford, not one you think you’ll be able to afford in five years. Spend cautiously, and take a conservative approach to how you handle money. Living below your means sets you up for financial success now and later on in life, and it means less stress if life throws you a curveball.

Don't Buy the Maximum Allowed

Along similar lines, remember that lenders don’t have your best interests at heart. Mortgage lenders often provide a maximum home purchase price based on your debt to income ratios—but you can (and often should) spend less. Auto dealers like to talk in terms of the maximum monthly payment, but that’s not the right way to choose a car.

Avoid Borrowing With Credit Cards

Unless you can pay off your credit card in full every month, you should not be using one. More often than not, credit cards lead to excessive spending, because you don’t “feel” the money being spent. Create a budget, and use cash or a debit card until you’re comfortable with your spending. You can always go back to credit cards for consumer protection and rewards after you’re out of the debt cycle.

Save for Emergencies

Sometimes, people end up in debt due to unforeseen circumstances—not everyday spending. While that debt might be unavoidable, in many circumstances it could have been avoided by saving up in advance for emergencies and other unexpected expenses. Start an emergency fund immediately, and try to build up to three to six months' worth of living expenses.

Updated by Sarah Brooks

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  1. Marketplace. "Ray Dalio Discusses the Anatomy of the Debt Cycle."

  2. Debt. "What Is Debt Consolidation?"

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