Limiting liabilities: Leading ways on how to avoid debt
Are you making financial progress or stuck living paycheck to paycheck? You’re not alone. In fact, about 80% to 90% of Filipinos don’t follow a strict budget and struggle to learn how to avoid being in debt. The good news is, with the right approach, you can turn things around by managing your finances better.
As of February 2024, credit card loans in the Philippines has reached over PHP 680 billion, from PHP 428 billion in 2022. It’s one of the most common forms of debt, often because it’s easy to accumulate but tough to pay off. But with a solid plan, you can avoid falling into this trap.
Here’s how to start:
- Understand your cash flow: Track how much you earn and spend. Know where your money goes each month.
- Set a budget: A simple budget, like the 50-30-20 rule, can work wonders. Allocate 50% for needs or essentials, 30% for wants or non-essentials, and 20% for savings, debt repayments, and investments.
- Review discretionary spending: Cut back on non-essential expenses like dining out or subscriptions you rarely use.
- Spend wisely: Stick to your budget, especially for non-essentials.
- Use your credit card smartly: Only charge what you can pay off monthly to avoid interest and fees. If necessary, opt for 0% installment deals.
By sticking to these good money habits, you’ll not only avoid debt but also build a more secure financial future with savings and emergency funds.
What are liabilities?
Liabilities refer to debts, obligations, and financial responsibilities you owe to an institution like your bank.
They are typically due and payable within an agreed period of time. Common examples include car loans, home loans, personal loans, or monthly installments for a laptop or smartphone that you recently purchased. If you’re not careful about the number of liabilities you have, you risk spending more than you earn. This can land you in long-term debt.
Tips to avoid debt
1. Understand your cash flow
How well do you know the ins and outs of your finances? Being “money smart” means looking for ways to make your hard-earned cash go further. This starts with understanding your personal cash flow, which considers all the money going in and out of your bank account.
Your cash flow consists of two factors:
- Income. This is the money you receive from your salary or wages, financial assistance from the government such as subsidies and allowances, and other types of income from investments.
- Expenses. This is the money you spend. It can be broken down into two categories: essential and discretionary expenses. Essential expenses are your living expenses such as utility bills, rent or home loans, groceries, and clothes. Meanwhile, discretionary expenses refer to what you typically spend on to maintain your lifestyle.
Having a positive cash flow occurs when your total income is greater than your expenses per month. In contrast having a negative cash flow means your expenses exceed your income. When managing liabilities, you always want to have a positive cash flow.
2. Set a budget
If you’re looking for ways on how to avoid debt problems, look no further than budgeting. With proper budgeting, you can create a positive cash flow that will put you on the right track to being debt-free. One way to start a budget is to apply the 50-30-20 rule, a favorite among budgeting beginners and financial experts. The 50-30-20 rule works by breaking your spending into three main categories:
- Necessities-50%: This category includes all living expenses you need to pay each month such as shelter, utilities, and food.
- Discretionary spending-30%: This covers all your non-essentials, such as entertainment and travel. It is basically anything you want but do not need.
- Savings-20%: This portion of your budget is for the money you're putting towards your financial goals, like a retirement account or an emergency fund.
To start a budget with the 50-30-20 rule, look at your monthly expenses. Track every peso you spent for the last three to four months. By looking at your expenses for the previous months, you can form an idea of how much you spend on a regular basis and set a budget.
3. Evaluate your discretionary spending
You need to evaluate your discretionary expenses too. Discretionary expenses can be divided into two categories:
- Obligatory spending– This refers to payments that you get billed for monthly such as your car loan, gym membership, and Netflix subscription.
- Disposable cash– This is the portion of your budget you spend on things such as travel or entertainment. Eating at restaurants and weekend activities fall under this category too.
There are nuances between obligatory spending and disposable cash, and the most essential tip to avoid debt is to understand these. For instance, you might get the newest smartphone on a monthly installment and tag it under obligatory spending. But if you still have a fully functional smartphone with great features, then you don’t need a new one. This means it’s more apt to put it under disposable cash.
4. Spend within your discretionary budget
Keeping your discretionary spending up to 30% is what limiting liabilities is all about. To help keep your discretionary expenses to a minimum, ask yourself these three questions:
- Do I really need it? For instance, if your commute to work is seamless and convenient, do you really need a car?
- Can I get a less costly version that will still give me all the features I need? Going back to the smartphone example, can you find a cheaper smartphone with similar or even better features?
- Will I need it permanently, or could I rent or borrow instead? For example, if you are going on a trip abroad and need a DSLR to capture great photos. Perhaps you can borrow a camera from a friend or rent one online instead of buying a new one.
Always ask yourself these questions before signing up for a loan. Once you've identified your discretionary expenses, you can make better judgments about their value and cut out unnecessary spending, so you stick to the 30% and stay out of debt.
5. How use your credit card wisely
When you use your credit card, you actually incur debt. This is not necessarily a bad thing. If you know how to use your credit card wisely, it is a powerful tool. Your credit card can make life better and more convenient. So, make sure that every purchase will contribute positively to your life.
Implement effective credit card management. Have the funds available to pay for your credit card bill on time and in full to avoid late fees and penalties. If you do not have the money on hand, look for 0% installment offers that allow you to make monthly payments at no added interest.
If you do incur late fees, pay them off at once as these fees compound over time.
6. Avoid Impulsive Purchases
Impulsive purchases are perhaps the biggest obstacle to saving and financial stability. Impulsive purchases are rarely within anyone’s budget. Thus, they’re often bought using credit cards or “buy now, pay later” schemes, leading to more debt than you can handle.
As we’ve discussed, debt can be good if they will lead to your goals. This where the difference between good debt vs unmanageable debt becomes obvious. Impulsive purchases, for example, a viral luxury bag that suddenly became available in the country, doesn’t contribute to your life goals.
Sure, that purchase makes you feel good in the moment, but it can derail your financial goals. So, the simplest way to avoid unmanageable debt is to avoid impulsive shopping.
7. Build up your savings
Your savings serves numerous purposes in your financial life. Emergency funds can serve as padding for unexpected expenses, such as car or home repairs. You can use your savings to pay for these expenses and use your usual budget for daily expenses. This way, you don’t need to get a cash advance or get into unnecessary debt.
For many individuals living paycheck to paycheck, all it takes is one major unexpected expense to get into bad debt. It’s easier to follow the tips on how to manage debt when you have a healthy savings.
8. Always have a plan
Being conscious whenever you use your credit cards or take on any type of debt is key to keeping your finances in order. Apart from having a clear purpose for your debts, you must also have a plan for how you will repay them.
Remember that loans are not a temporary patch for financial mishaps. They themselves can become a problem.
Make sure that you can afford the monthly payments, that the loan term is manageable, and that you can pay on time. Having a repayment plan ensures that you meet your obligations without stress and allocate your resources effectively.
How to avoid debt: It’s all about adjusting your spending
When you're still learning how to budget, it's okay to not hit the 50-30-20 ratio right away. For instance, if you find that your living expenses take up more than 50% of your budget, you can tweak your spending over time and eventually work up to that ratio. Having a clear delineation between the percentages in your budget, understanding the composition of obligatory spend versus disposable cash, as well as using your credit card wisely, also help you in managing your liabilities so you don't overspend on the things you can live without.
Use the steps above as a guide not only on limiting liabilities but on how to avoid debt problems. As you build momentum, you can actively avoid debt and look toward more long-term financial goals, such as saving for a house or setting up a retirement fund. To help you conveniently track your expenses, use Metrobank's digital services.
Wherever you are and whatever device you use, you can access your Metrobank account to actively monitor your transaction history, check your balance, pay your bills, and so much more. It’s easier and more secure banking at your fingertips.
