Five Smart Financial Habits That Will Help You Stay Out of Debt

Amid the pandemic, data shows that the average U.S. citizen faced another pressing concern: their personal finances. According to an analysis by Experian, the total outstanding U.S. consumer debt grew $800 billion to a record high of $14.88 trillion. This six percent increase was the highest annual growth recorded in over a decade. Let that sink in. There is a bit of good news, though: Overall, "bad" debt—typically referring to items purchased that don't appreciate in value like clothing or trips—decreased, while "good" debt—debt that may offer a return on your investment, like student loans or a mortgage—increased. "When debt is used strategically, it can help build wealth," says Kathy Entwistle, managing director and private wealth advisor for Morgan Stanley. "Whether debt is ultimately beneficial boils down to this question: Will this debt pay me back more than what I put in?"

Still, many financial experts say it's best to avoid debt altogether—especially if you already have mounting debt, says Colleen McCreary, chief people officer of Credit Karma. Why? Besides the obvious financial burden of paying money back over time, debt can directly influence your credit, says Entwistle. "Your credit score has real-life ramifications—it is your financial DNA and could impact your interest rates on loans (including mortgages), limits on credit cards or loan amounts, access to credit card rewards and interest rates, car insurance premiums, ability to rent or own a home, and need for security deposit on utilities." Not to mention, facing mounting debt is undoubtedly stressful. In fact, studies show a correlation between debt and feelings of depression, anxiety, and stress.

So, how can you avoid debt, regardless of whether it's "good" or "bad" for your overall financial picture? Here's what the experts have to say.

Know your credit score.

"Your credit score indicates your perceived financial trustworthiness and may be very costly to you via higher rates or lack of access to loans," says Entwistle. As such, it's important to monitor your credit score. Check it at least once a year, she says. And, if necessary, take steps to improve it—close unnecessary cards (like store cards), pay your bill on time, and so on.

Conduct a full review of any debt you do have.

Fully asses what your debt looks like, says Entwistle. Print out all of your statements and take note of debt type, interest rates, and interest deductibility. This way, you can make sure you aren't missing any monthly payments. Just as importantly, you can begin to make a plan for tackling your debt. (You can even use free tools, like Credit Karma's Debt Repayment Calculator, to get a sense of how long it will take to pay off your credit card debt.)

Pay your debts time.

Once you have a handle on your debt, establish your plan of attack. "Set calendar invitations on your phone or laptop that remind you to pay off your debt on time and in full," says McCreary. "You can also try to make all your payments on one day to make it easier—call your lender and other companies who send bills, like your utility company, to see if they can move the day you pay your bill to one set day."

Maintain an emergency fund.

The best way to avoid taking on more debt is to have enough cash to purchase the things you need. But sometimes unexpected expenses arise. An emergency fund (liquid money that's easily accessible and available to you) can help ensure you have enough in the bank to cover these costs—at least to some extent, says Entwistle. Aim to have three to six months of your monthly expenses set aside in an emergency fund.

Think carefully before taking on more debt.

"Taking on debt is a big decision," says McCreary. "Before applying to borrow money, ask yourself some questions to make sure it's the best next step for your finances." Think about things like how much of a monthly payment you can afford, what happens if you can't make the payments, and whether the debt will ultimately boost your earning power, she explains.