Debt-free living: What it is and how to do it

Owing money can feel like a literal weight on your shoulders, especially when you're carrying a large debt balance. It’s natural to dream of a day when all the cash you earn is yours to keep and not already earmarked for your creditors.

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However, being in debt doesn’t necessarily have to be a drain on your finances and future. We’ll define debt-free living and explore the pros and cons of the lifestyle. We’ll also share some strategies to help you achieve the major money milestone. That way, you’ll be prepared if you decide to pursue this goal.

Debt-free living and what it means

When you imagine living debt-free, what do you see? If you’re like many, you may imagine a life where you’re credit invisible and have absolutely zero debt from any creditor.

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But, while being credit invisible is true debt freedom, it comes with a price. If you want to buy a home, go to college, or pay for another large expense, you’ll need the cash to cover it. That means you may have to wait years or decades longer to fulfill a dream than your peers who took out loans. 

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Plus, if you never borrow money, you can never build credit. While that may not seem like a big deal since you’ve sworn off debt anyway, you may find yourself scrambling if you genuinely need a loan and can’t qualify for one.

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Fortunately, there’s a way to balance having financial freedom with having a good credit score and access to credit when necessary. Your path begins by understanding the difference between good and bad debt.

Good debt vs. bad debt

Some types of debt are worse for your finances than others. For instance, high-interest credit card debt is considered bad debt because it will cost you a significant sum until you pay it off. Plus, if you charge groceries, gas, and other consumable goods to your account, you’ll pay all that interest without having something lasting to show for it. 

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On the other hand, mortgages, student loans, and business loans are generally referred to as good debt. Their interest rates are usually much lower than those of credit cards. In addition, the debt finances something that could appreciate or help you earn more money.

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However, when used responsibly, any debt can help you improve your financial situation – even credit cards. If you pay off your credit cards each month, you can earn valuable rewards and maintain a high credit score without paying interest or digging yourself into a deep debt hole.

How to start living debt-free

If you’re ready to start your debt-free life, follow these steps:

1. Build a budget that works for you

First, you must create (and follow) a budget. Think of your budget as a personalized spending plan that accounts for your income, expenses (including debt payments), and financial goals.

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If you’re unsure how to put a budget together, consider following a popular model, like zero-based budgeting. With this approach, you assign every dollar you earn a job. At the end of each month, your income minus your expenses equals zero. 

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This method can help you keep tight control over your money. However, it can be challenging to stay on track if you have a variable income or encounter unexpected expenses.

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The key is to explore several methods to see which best fits your life. If none of the popular options appeal to you, feel free to create a custom budget.

2. Eliminate your current debt

Now that you know how much cash you can throw at your debt, it’s time to decide how you’ll pay it off. You have several potential strategies at your disposal, including:

• Debt avalanche is where you pay off your debts in order of highest to lowest interest rate to save money in interest payments.
• Debt snowball is where you pay off your debts from lowest to highest balance, which can give you confidence and build momentum.
• Debt relief options may include negotiating a reduced interest rate, a more budget-friendly repayment plan, or a lower principal balance.
• Debt consolidation involves securing a lower-interest loan to pay off one or more high-interest debts to save money, shorten your repayment timeline, or both. For example, consumers often take out a personal loan to pay off credit card debt.

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Remember: Whichever option you choose, the process will take time. You didn’t get into debt overnight, so you likely won’t get out of it overnight.

3. Build an emergency fund

Could you cover a $1,000 emergency in cash? If you said no (and many people are in the same position), you’ll either have to take on debt to resolve the issue or leave the problem unfixed.

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It’s a smart idea to build an emergency fund as you pay off your debt. That way, you can respond to a personal crisis without adding to your financial woes.

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It’s okay to start small. Set aside a few dollars from each paycheck and watch the balance grow. Then, when you get a windfall like a tax return, work bonus, or inheritance, you can boost your account.

4. Live within your means – or below it

It’s tough to save or pay off debt when most or all of your money supports your lifestyle. While scaling back can be tricky, living frugally is your key to becoming debt-free. Not only will living within your means help you find the cash to pay off your existing debt, but it can also help prevent you from taking on new debt.

5. Have a plan for taking on new debt

As you pay off your current debt, it’s wise to think about how you’ll handle debt in the future. You should avoid racking up and carrying large balances on your credit cards. You should also think twice before borrowing money to cover a discretionary expense, like a vacation.

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However, taking on new debt is sometimes inevitable if you want to achieve a specific outcome within a set timeframe. For instance, if your goal is to buy a house in the next three years, but you only have $50,000 in the bank, you will probably need a mortgage.

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Fortunately, you can make sound choices when it comes to obtaining a home loan:

1. You can purchase a modest residence in a lower cost-of-living area.
2. You can commit to a monthly loan payment that fits comfortably into your budget rather than buying a property at your maximum pre-approved amount.
3. You can shop around and find the mortgage with the best interest rate and lowest fees.

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The bottom line: You need to understand how a new debt will impact your financial life and decide if the consequences are worth it.

6. Plan ahead for major purchases or milestones

Your emergency fund can help you weather unexpected financial storms. But oftentimes, you’ll be able to see a significant expense coming from a mile away. You can keep yourself out of debt by saving up for these costs in advance.

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For example, let’s say you’re getting married in two years and need $15,000 to pay for the event. If you set aside $625 a month between now and your wedding day, you can pay for your nuptials in cash.

7. Avoid lifestyle inflation

As your financial situation improves, you may be tempted to use your newfound cash flow to make expensive discretionary purchases. While small upgrades and splurges may be appropriate, avoiding lifestyle inflation is important. 

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Lifestyle inflation is when your spending level rises to match your available resources. If you give in to it, you could quickly find yourself short on funds – and taking on new debt.

8. Check in with yourself regularly 

Deciding to get out of debt is a big deal, and taking the steps to get there should be celebrated. However, your plan for debt-free living can’t be set it and forget it.

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You need to keep tabs on your progress continuously. Ask yourself: 

• Are the numbers moving in the right direction? 
• Should I be doing something different? 
• How do I feel about this journey? 

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Don’t be afraid to change course if necessary. You know the story's eventual (hopeful) ending, but you can write the chapters leading up to it as you see fit.

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Final thoughts

Living debt-free is a worthy goal that’s shared by many. However, the extent to which you pursue it and the road you take to get there are entirely up to you.