(This article was originally published on the 19th July 2019 and updated on the 4th August 2020).
The worst financial mess one can ever get into is to be saddled with debts. Many are doomed the minute they start missing out on payments or evading their creditors. Those are clear signs an error in judgment was committed to obtaining the debts. The debtor will come to realize belatedly that most of the obligations originated from bad debts. Thus, avoid getting into a bad debt to be free from financial misery.
What is a bad debt?
In simpler terms, a bad debt is described as an expense that was provided to an individual that is estimated to be uncollectible. Some example of bad debts are cars, other impractical spending (i.e. clothing, electronic items, cosmetics, etc.), credit card and so on. These are bad for you when you are spending above your means. To sum it up, when the payment due dates come for your loan or credit card, if you are in no position to pay, it means that you would end up with a bad debt.
But remember, not all debts are bad. Some debts are actually good debts. Read our article where we compare the differences between good debt versus bad debt.
Be wary of bad debts
A sound personal finance advice but often taken for granted is to avoid accumulating debts. Just because you have easy access to cash through personal loans or cash advances, it does not mean you have to acquire debt.
Remove that perception. It will only lead you to financial ruin. Instead, you need to have consciousness on bad debts. Bailing out of debt is never easy and maddening especially when you are paying for a bad debt.
How to avoid getting into a bad debt?
1. Make a budget plan
Having a budget plan is an important aspect of financial life. Understand its purpose. Your budget will tell you exactly your ‘real’ financial capacity. If you see that the amount is limited, it will inhibit from borrowing as paying for the loan is obviously a problem. You may want to try using this easy budgeting method called the 50/30/20 rule.
2. Build an emergency or buffer fund
From out of your budget, allocate a certain amount to start building an emergency fund. Once you have a buffer fund, you will no longer be inclined to borrow. Your emergency fund will serve as your safety net against bad debts.
3. Exercise self-restraint
With a budget in place, exercising financial discipline comes next. Apart from overshooting the budget, the pitfalls of many are the lack of self-restraint. You’ll struggle at first but as you gain control of your spending, you’re creating a shield against bad debts.
4. Know your needs and shackle your wants
By exercising self-restraint, you are able to make a clear distinction between your needs and wants. Your state of mind will change from careless to frugal. The penny-wise will always forego of the luxuries in favor of the essentials.
5. Do not purchase on credit
Never make it a habit to purchase on credit or make cash advances. This is the characteristic of ill-advised individuals. From here on, reserve the use of credit cards for worthy purchases only. If self-restraint is your shield, curbing your credit card use is the armor against bad debts. Applying for additional credit cards is neither the solution.
6. Do not compound bad debts with bad debts
The psychology of debt-ridden individuals may be confusing at times. Instead of working to reduce debts, the tendency is to finish off the credit limit when it nears the maximum. Bad debt is staring you in the face. Accumulated debt is the result of a series of debts and non-payments. The remedy is to pay outstanding debts and not acquire new ones.
7. Always go for the good debts
If you need extra cash to pay for or invest in something of value like home equity, tuition fee, and a business venture among others, then borrowing is warranted. A good debt would be a personal loan that offers the lowest interest rate and flexible payment terms. Be wary of using credit cards that charge exorbitant interest rates.
Before taking on a personal loan, be sure you have assessed your cash flows and capacity to make prompt payments. Always go for the good debts like debt consolidation. Never abuse your credit privileges by taking on a bad debt that converts into a financial burden.
8. Do not borrow to keep up with the status of others
Borrowing for the wrong reasons is a fatal blow to your finances. Some people borrow in order to maintain or keep up with the status of others. There is no benefit when you covet what others possess. Better keep your envy and jealousy in check otherwise you end up obtaining a bad debt.
9. Do not allow others to use your credit
Having others use your credit is a lethal mistake. If you accommodated a friend who is unable to pay the debt, then the liability becomes your own. Also, avoid signing as co-guarantor to a loan. If the loan turns sour, you will again shoulder a debt burden that is not your own. Be discerning when extending help.
10. Consider the effects of bad debts
A major deterrent to bad debts is the awareness of its consequences. Protecting and maintaining a good credit standing should be the goal of the responsible borrower. Bad debts will likely turn you into a high-risk customer.
Expect outright rejections when you apply for new loans. Even employment prospects might check your credit history. You will be incessantly pestered, if not harassed, by collection agencies. The consequences are severe. Therefore, think through it if you are tempted to borrow unnecessarily.
Cultivate your financial intelligence
One of the main doctrines of personal finance is the cultivation of financial intelligence. All the effective ways mentioned here are linked together and intended to insulate you from the snares of bad debts. So save yourself the trouble of dealing with bad debts. The headaches and anxieties that come with them are not worth it.
In case you are caught up with a bad debt, try seeking advise from our friendly consultants at Direct Lending. We are a personal lending platform that offers safe and affordable bank and koperasi loans especially for government servants. We are ready to help you access your financial struggles, if any with absolutely no charges. Check your eligibility for free today with our smart eligibility checker. Our rates are as low as 2.75% or as fast as 2 working days!