Do You Know How the Debt Spiral Works?

When you first borrow money it might be so that you are able to build credit and usually starts with a store card and a credit card, but as time goes on, you may find that your wallet is full of plastic, your bank account is looking empty and all your money is going towards debt. These are signs that you are being dragged into a debt spiral.

debt spiral

If you feel like you are heading towards the debt spiral, then you need to know the signs and how you can avoid it before you get yourself too far into debt.

You First Get a Store Card

We all know that we need to build credit and have a good credit score so that one day we are able to take a reasonable loan when we need it. Often we start our credit journey with a store card as it is one of the easiest forms of credit to qualify for and you won’t need to have an existing credit record.

You will need to use your store card so that you can start building your credit score. This means you have purchasing power, but you will need to resist overspending and only buy the essentials that you would have normally bought and are able to afford to pay back.

If you buy more then you can afford with a store card, you are going to have debt and a high interest rate to contend with. Avoid impulse buys and only spend what you can afford.

Another Type of Credit

With a store card, you will gain instant buying and after a store card, many will get a credit card as well. A credit card can be used almost anywhere whereas a store card can only be used at the store that issued it, which means you have more buying power with a credit card.

You may think that you need a credit card to build your credit score further or you need it for unexpected emergencies, however, you only need one credit account to build credit card, so rather stick to one type of card, which should be your credit card. Your credit card doesn’t have limitations on where you can use it, but it does have a high credit limit, which can lead to large purchases you can’t afford and debt.

In order to avoid such large spending, especially if you are impulse buyer is to lower the credit limit and to remind yourself of what could happen before you pull your card out.

If you are already sitting with a maxed out credit card and you are not sure what you bought that was essential, then this is already a red flag of the debt spiral.

The debt spiral doesn’t end there…keep reading…

Taking on a New Debt

There might be times in life where you may need to take on new debt, for instance, you may need a new car. If you have a solid credit score and have been making your monthly repayments on your credit and store card, then you will qualify for vehicle finance.

You may think that if a lender is willing to offer credit then you must be able to afford it. However, you are the only one that really knows what you are able to afford.

It might be wiser for you to save up and drive your old car until you are able to afford a new car with cash. A car loan will put you into further debt, but if you really do need a new car and you need to finance it then create a detailed budget. This budget should forecast your finances for the next several months that takes into account your current debt and the potential for other vehicle related expenses.

If your accounts are already maxed out and new vehicle payments will push you beyond your limit then do not accept the car loan.

debt

A Real Emergency

Let’s suppose that you decided to get that new car, even though you couldn’t really afford it and then a real emergency crops up, an unexpected expense that you need to pay for so that you can carry on with your day to day life. How are you going to pay for it? You may opt for a personal loan to cover the expense.

At this point, you may have not missed a payment and your credit score looks good, but in actual fact, you are broke and on the edge of the debt spiral. But you carry on and sign the loan agreement and your debt is taken further than what you can afford.

A Debt to Cover a Debt

So what happens now? You start defaulting on your payments and your credit score starts taking damage. You then think that you should take out a loan to pay for your existing debt, but because of your suffering credit score, you may end up with a loan that has a high interest rate. This can lead you to take out one loan after another in order to pay your lenders. Now you are in over your head and struggling with mounting debt.

This could have all been avoided if you had taken note of the earlier warning signs including maxed out credit cards, debt that is more than your savings and a budget that predicts cash flow problems.

If you are heading in this direction, then you need to stop and focus on reducing your debt and fixing the way you spend money.