You’ll never be wealthy as long as you owe other people more money than you have. So before you can be financially free, you’ve got to get rid of your bad debt.
First up, let’s be clear: we’re talking about bad debt here. Having some debt is probably unavoidable, and not all debt is bad. In fact, some debt can even make you money in the long run. Unsurprisingly, we call this useful, money-making debt good debt.
To be financially free, you need to pay off all your bad debt as soon as you can, avoid getting more, and only make room for good debt in your life.
You can tell the types of debt you have by knowing what assets you have. For example, if you’re in debt because you have a student loan, that’s actually a good type of debt because a student loan will get you a qualification, which will put you in a better position to get a job. You can see it this way: studying increases the value of you, your best asset.
Good debt pays for itself in the long run. Another example of good debt is a home loan to buy property, especially if you can rent out that property for more than your loan repayments – because then you can sit back and earn money for doing very little work.
Bad assets are things that eat wealth over time because they lose value or cost money to keep. A car is a classic example, but so are smaller things like your clothes, laptop or furniture.
Buying up loads of bad assets is bad enough. Using debt to buy these bad assets is so much worse. And we call this type of debt "bad debt". Using your credit card to buy groceries is an example of bad debt.
Bad debt is dangerous because it can get out of control. The debt death spiral looks like this:
If you keep borrowing to pay for you lifestyle, you’ll end up needing debt just to pay for your debt. You’ll be desperately trying to scrape by with no breathing room for making big life changes or surviving unexpected life events. You won’t be able to live your dreams. You’ll be financially enslaved.
It’s bleak. But that doesn’t have to be your future.
The first and most important step is to always and forever more spend less than you earn. That’s not a once-off thing: it’s a lifestyle change. Once you’ve got the hang of using a budget, you can start to pay off your bad debts. And while you’re at it, develop a mindfulness when it comes to spending your money.
Making a list of all your debt is a great first step. That means everything that you owe other people, especially if it’s incurring interest. Then, use a budget to spend less than you earn, and consider paying off your worst debt first; the debt that’s earning the highest interest. The worst culprit is usually your credit card because the interest on credit card debt is very high.
So, stop buying things you can’t afford and start buying into your freedom. It may be scary at first and it’ll take some work to change those habits that are bringing you down. But it’s a small price to pay for your freedom.