Debt Creep and Debt Spirals

Occasionally, debt might be useful. However, it can also often be dangerous. Debt has the uncanny ability to slowly take over your finances without you even noticing until suddenly it becomes a massive problem and spirals out of control.

Debt Creep

If you’ve done much lawn care, you’re probably familiar with how different weeds can ‘creep.’ They slowly inch their way onto your lawn, gradually taking up more and more square feet. In many ways debt works the same way. It’s so easy to add just a little debt each month, perhaps to cover the few expenses at the end of the month when cash is tight.

 

This is especially dangerous with revolving debt, such as lines of credit and credit cards where you can add to your debt simply with the swipe of a card. At first, this doesn’t seem like much of an issue. You can cover a hundred dollars worth of expenses and only see your monthly credit card payment increase by a few dollars. In fact, you can probably get away with this for several months and not even notice your credit card payment slowly growing! It’s easy to forget that you now are not only on the line for those extra purchases, but also for interest on top of that.

The problem is, every time you do this, your monthly debt payments slowly get a little larger, taking a little more out of your monthly budget, and leaving even less money to cover your regular expenses, in turn making it that much harder to avoid taking on new debt the following month.

Below are two charts showing how your balance will grow over 6 years if you consistently use your credit card to cover a $100 budget shortfall. After just 6 years you’d owe over $13,000 and have a minimum payment of over $300.

Debt Spiral

Before long, debt creep spins out of control and turns into a debt spiral. Remember that hundred dollars that you could charge to the card for only a few dollars in monthly payment? Suddenly your monthly payment is hundreds of dollars. If you had trouble covering those hundred dollars in regular expenses, you’re really going to have trouble covering the hundred dollars in regular expenses plus hundreds of dollars in debt payments, so you keep on throwing your regular expenses on the credit card, and your card payment keeps on growing, and you keep on charging more and more to the card.

Debt usually continues to spiral until you either wake up and smell the coffee (or the poop) or until one day all your cards are rejected because you’ve maxed them out. Except then the credit card calls you up and kindly offers a personal loan at a lower rate to pay off part of your balance so you can continue the fun!

Not Just Credit Card Debt

While credit card debt is a common cause of debt creep and debt spirals, it’s not the only culprit.  A fast talking salesperson can put you in a $400/month, 8-year car loan when you had only budgeted for $350/mo. Suddenly you’re watching your car depreciate faster than you’re paying the car off. And because your car is ‘underwater’ you can’t sell it without making a large payment to make up the difference between car value and loan value. And you can’t make extra payments because you’re already stuck with higher payments than budgeted.

Even with a mortgage, which almost all personal finance experts consider good debt, you can experience debt creep. Soon after you take out the mortgage on the house, you’ll likely start getting lots of offers from the bank for Home Equity Lines of Credit or HELOCS. These offers will be tempting. They prey on your dreams of improvements and remodeling that you can do to your new home. Or perhaps you didn’t anticipate all the extra costs of buying a home and now need extra cash to cover some of these expenses. They’re also good at making themselves sound like great deals, with lower interest rates and flexible payback schedules than other forms of debt. Before you jump, ask yourself if you’d be better off saving up and paying cash for whatever you’re wanting to use the HELOC for. Even better, consider these things before you buy the house in the first place.

Avoiding Debt Creep and Debt Spirals

As they say, an ounce of prevention is worth a pound of cure. This couldn’t be truer than with debt. Because of the way compound interest works against you with debt, it’s far easier to avoid debt altogether than to try and dig yourself out of a debt mountain.

But staying out of debt is harder than ‘just saying no.’ You need a budget. A budget helps you plan ahead for all your expenses. Without a budget, necessary expenses are liable to jump up when you least expect them, after you’ve spent your entire paycheck on other things. A budget ensures that you are spending less than you earn, rather than more than you earn. So if you haven’t done it already, sit down and draw up a budget. You can make it easy and automatic, or you can make it visual with the envelope budget. Just have some sort of plan in place.

Before you take out ANY debt, stop and carefully consider if it fits comfortably in your budget. And always ask yourself if you’d be better waiting until you can pay for the item in cash. The vast majority of times, it is better to not go into debt.

Fixing Debt Spirals

Perhaps you’ve already landed yourself in debt. That ounce of prevention is too late. If you catch debt creep soon enough, you can nip it in the bud fairly easily. You can ‘tighten your belt’ for a few months, completely stop taking on more debt and get your debt paid off.

Trim Expenses

Full-blown debt spirals are harder to tackle. Fixing a full-blown debt spiral can take years. The first thing you need to do is stop taking any new debt. Again, this means you have to make a budget. Remember, this budget has to fit all your debt payments and all your expenses into your take-home income. This probably means making serious lifestyle changes! Identify your biggest spending areas. Aggressively cut out the ‘fat’ from your budget. If the problem is particularly bad, you may even need to downsize house or cars. Just do whatever you need to do to fit your all your debt payments and expenses within your income.

Seek Lower Interest

Also, evaluate your options for refinancing your debt. Credit card debt carries particularly high interest, so if possible, it may be prudent to roll your credit card debt into a lower interest option, such as a personal loan, HELOC or mortgage. Be cautious here- watch for any fees you incur doing so. If there are fees, just be sure that the fees are less than what you’re saving on interest.

Adopt a Strategy

Finally, adopt a payoff plan. At first, you’ll likely only be making minimum payments on your debt. However, when you’ve paid some of your debt down, and your minimum payments start shrinking, you’ll find yourself with a little breathing room in your budget. If you need to allocate this to an emergency fund, this is a priority. If you haven’t budgeted anything for fun, go ahead and do so to avoid budget burnout. However, if your emergency fund is healthy and you already have a modest amount budgeted for fun, don’t blow this extra cash! Start making extra payments on your debt. Look into the avalanche and snowball methods of paying down debt. And finally, keep up the good work! Stay persistent until you’ve knocked all your debt off the books!

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- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.