A Simple Plan To Beat The Debt Trap

The current recession and economic downturn is deeper than anything the country has seen since the Great Depression. As a result four out of five middle-class Americans say that maintaining their standard of living is tougher than it was a decade ago. Due to recent tightening of home-equity lines of credit as well as credit card limits, debt problems are mounting and have started dragging down many Americans. Even those who believed they were using their credit responsibly are beginning to feel the pinch especially in light of recent mass layoffs that by early spring of this year, left 13.2 million Americans unemployed. According to a recent USA Today article, 78% of Baby Boomers have mortgage debt, 59% have credit card debt and 56% have auto loan payments. According to the American Banker's Association, the average family today carries $8,000 in credit card debt alone. None of these statistics seem very positive to those who have already lost their jobs or at the very least still find themselves in a shaky employment environment.

Over the past decades, Americans have become a buy now, pay later society. We want what we want and we want it now. Up until now we could buy a home, a car, start a business, or take a pricey vacation on credit and not be bothered with having to wait. But as is almost always the case, it seems now that it is time to pay the piper for the past availability of no money down, easy credit. America has not been known as a nation of savers but a nation of consumers and our seemingly insatiable appetite for things seems to have gotten many of us in a bind.

If there is any silver lining to the whole recession it may very well be that we should all see quite clearly now who the winners and the losers are when it comes to easy credit. The irresponsible behavior of lenders is in large part to blame for the economic recession yet the lenders are being bailed out by the federal government with TARP bailouts. Meanwhile consumers, many out off work, facing foreclosure and saddled with debt that they cannot pay, aren't being bailed out by anyone. It should now be apparent that easy credit exists to enrich the banks and lenders not to make our lives easier or better.

Many Americans yet face some trying economic times and for many there is no quick fix solution. But if you can get past the difficulties in the short term, in the long term there are some solid steps you can take to put yourself on solid financial footing and avoid falling prey to the debt trap again in the future.

The first step is stop using credit cards except for the direst of emergencies. As financial guru, Dave Ramsey preaches, when you use plastic to pay for purchases, statistics demonstrate that you will spend 12 - 18% more than you would if you were paying cash.

In addition consider this example; assume someone has a credit card with a $7,000 balance, an interest rate of 17%, and makes the minimum monthly payments (about 2%).

It will require (get ready for this) more than 40 years to pay off the entire debt! Not only that, they would end up paying almost $14,000 on the $7,000 loan. Think of all the other uses that money going to interest could be used for. Credit cards are a major issue when it comes to staying firmly in the clutches of the debt trap or of escaping it.

Another key to avoiding the debt trap is to follow the tenants of what by now has become almost a cliché, "pay yourself first." Cliché or not, it is vitally important that you find ways to sock away part of your income each and every month. First, everyone needs an emergency fund that is there when unexpected budget-busting expenses like expensive home or car repairs or unexpected medical expenses crop up. Having an adequate emergency fund should eventually make it unnecessary for you to rely on credit cards even for emergencies. Financial experts vary when it comes to how much is needed for an adequate emergency fund but as a starting point, aim to save an amount equal to three months of your expenses. Once you reach that goal, try to save enough until you have an amount equal to a full six months of expenses. This provides a parachute of sorts in the event of a job lay-off or major unexpected expense.

There is another big advantage to having a large emergency fund set aside. It offers you the opportunity to become your own banker for those things you need, or at least desperately want now but would like to pay for over time. Rather than pay your banker, why not pay yourself? Say you just have to take that Caribbean cruise with a price tag of $2,000 and you happen to have $6,000 socked away in your emergency fund. Instead of withdrawing the $2,000, paying for the cruise and forgetting all about it after you return home, why not consider it a loan? Decide on the length of time you wish to repay the loan (the term) and I encourage you to even set up an interest rate. Simply use as your interest rate, the rate of return you are receiving on the account where you deposit your emergency fund. For our example, we will use 5%. Doing the math, a $2,000 loan, for a two year term at 5% interest means you will be making payments of $91.67 per month for twenty-four months. At the end of two years, you will not only have recouped the original $2,000 from your cruise and returned your emergency fund to its former balance but will have actually added a nice profit of $200 from the interest paid. It's almost as if you not only get back every penny you paid for an enjoyable Caribbean cruise but pocketed an extra $200 besides. The larger your emergency fund becomes, the larger things like cars for example that you can self-finance instead of going to a lender and allowing them to benefit from all that interest.

Debt is a trap and it is a predicament that is difficult to get out of. It takes a lot of will power, discipline and courage to escape it. But it can be done. I know that from personal experience. A little over ten years ago after a divorce, I found myself in desperate financial straits. I had a vehicle re-possessed and credit cards charged off which combined to ruin my previously pristine credit rating. As a result I couldn't have borrowed money if I wanted to. It was then that I instituted the very plan I have proposed here. I became a saver and began acting as my own banker when I needed a loan. Now, years later, even though my credit rating has been restored and I could borrow money if I wished, I simply choose not to. I lend to myself out of my emergency fund and repay myself with interest. Not to boast, but in the past five years I have taken first class vacations to Alaska, Arizona, Canada, Hawaii and Europe, all self-financed. Since I don't have a pile of debt to service, I am easily able to repay my "loan" in 12 months and the next year I'm ready for another relaxing vacation. So trust me, it really does work. Imagine how much you could put toward your retirement or a nice vacation or something else you really want or need if you just didn't have those credit card or car payments. This is how the wealthy build their wealth. Beating the debt trap isn't easy but it can be done.