Debt accumulation can happen for many reasons and come from a variety of sources. Some are slow leaks that you may not recognize until it is out of control. Other times it may come as a flood with fast accrual from a single event. The ability to identify the root cause of your debt build up can prevent the re-accumulation of debt once you have worked to pay it off.
Reduction of Income or Underemployment. Various life events can cause your income to fall drastically and suddenly. The faster you respond to these events the less debt buildup you will incur. Common causes of income reduction include job loss, a new child when one parent stays home, or an injury that prevents you from working either temporarily or permanently. Underemployment can be the result of only acquiring part time work, when full time is needed. When your income is reduced, it is essential to reduce spending as quickly as possible so it is aligned with your new income levels. Failure to do so will result in rapid debt accumulation. For more details on how to accomplish this, see: https://www.strategicconsulting.com/blog/what-to-do-when-you-lose-your-job/.
Increased Expenses Whether you have expanded your family, experienced a family illness, or are suddenly taking care of aging parents rising costs can derail a budget if an emergency fund is not in place. When these expenses are seen as temporary it is natural to begin charging expenses to keep the family going. This can lead to significant debt accumulation, especially if you don’t reduce spending in other areas to make up for the unexpected costs. Often higher costs occur when income falls creating a volatile situation with regard to your finances.
Poor Money Management and bad financial habits can range anywhere from lack of a budget to impulse spending. Anytime you spend more than you earn you will have debt accumulation. Establishing good money management skills will enable you to stretch the money you earn as far as possible. Not paying attention to spending is one of the primary reasons debt builds up over time.
Lack of Financial Understanding Financial illiteracy often leads to higher expenses. Understanding the rules for bank accounts, loans, and credit cards can reduce fees. For example: knowing a credit card has a zero grace period but a vehicle loan generally offers a 5-day payment grace period can save you in late fees. While reading the fine print may be boring, knowing the rules of engagement can reduce costs.
Divorce can take a terrible toll on finances. Essentially, when you get a divorce you have the same income which must now maintain two households instead of one. This can eat up savings, reduce retirement funds, damage credit, and reduce your current standard of living. Having a clear understanding of what bills you are responsible for and what savings you can claim may reduce the negative financial impact often seen with divorce. Creating an amicable environment with your soon-to-be ex-spouse can reduce the costs of the divorce, freeing up money for everyday expenses.
Gambling is a common source of entertainment yet it can be very costly because of its addictive nature. It is easy to get caught up in the excitement of winning. The truth is that gambling is extremely profitable for companies who operate these businesses. Owners are very wealthy and they count on your losses to pay for the high dollar amenities found in casinos. The newest form of legalized gambling is seen in the form of the lottery, which is now available in most states. When you consider that lottery gains are used for state funding needs, it is not difficult to understand that the percentage of people who win are a small percentage of people who play. The lottery is justified with its cheap tickets. It’s only a dollar, or $5 to play, yet these costs can add up and cut into your long-term financial goals.
Business Failure is another common cause of debt accumulation. While many business investments pay off handsomely, others go out of business leaving owners with high debt you in which they are personally liable. Business owners sometimes believe as long as the loan is in the business name, if the business fails, they will not be on the hook for the debt. Unfortunately, most lenders require owners to personally guarantee the debt, meaning the owners are responsible for the debt even if the business does not survive.
Spending Anticipated Income before it arrive can be another source of debt accumulation. It is easy to overestimate the amount that you will receive from a future income source and feel you can spend accordingly now. If the money is charged to a credit card before it arrives, you could find yourself with high interest rate debt you had not counted on. Sources of windfalls might be from tax refunds, inheritance, or end of year bonuses. Treating these windfalls for reducing debt, building an emergency fund, or long-term goals, instead of increased spending will improve your long term financial health.
Lack of Savings is another key reason debt accumulates even when you work with a carefully planned budget. If money is not set aside for the unexpected, you will find yourself charging these expenses and increasing your debt. Putting money towards savings each month will enable you to tap into these funds as needed. Unexpected costs can come from yearly or quarterly bills you failed to budget for, unexpected car repairs, home repairs, or other emergencies.
Lack of Insurance or inadequate insurance can also lead to debt accumulation. High medical bills can occur if someone gets sick. High funeral expenses can occur if a loved one dies unexpectedly without life insurance. The idea of insurance is to protect you when things go wrong so you are not required to come out of pocket with large amounts of cash when life happens.
Lack of Communication can also result in higher expenses and poor financial decisions. This is especially true with joint accounts, where lack of communication can result in higher fees. One advantage of making financial decisions with a partner is the ability to brainstorm and discover more effective strategies when ideas are combined.
Educational Debt is now becoming a heavy burden to the upcoming generation, and those who return to school in an effort to improve job prospects or gain a promotion. Unfortunately, this debt burden is often not rewarded with a higher-paying job that would enable you to cover the debt payments. Selecting degrees or educational programs directly related to a specific job or promotion you are looking for can prevent this from happening. While student loan debt generally comes with low interest rates, high balances can still result in payments that are an obstacle once repayment is required.
Whether you understand the rules of incurred debt or not, you still become responsible for paying it off. Adding debt to the budget should be carefully considered. It’s more than just being able to make the minimum payment. Also, look at the cost of the debt and how long it will take to pay off. The burden of carrying long-term, high-interest debt can prevent you from funding other long-term financial needs. These decisions can take decades in which to recover.