Recently I wrote about the transition from “becoming debt-free” to “living debt-free”. One reader e-mailed me some advice that I felt did a good job summarizing what everyone had said. The following was written by James Crocker, and is an excerpt from a much longer message. This post has been edited for clarity.

Congratulations! You’re about to accomplish something many people have never done, and something that many others never will do: become debt-free. (Well, except for your mortgage.) It is no small feat, and I commend you not only for your efforts, but also for the helpful information you’ve spread to others.

I know where you are coming from. I struggled to get out from under student loans, car loans, and credit card debt for many years. It took a long period of living below our means to pay down all of our debts. Currently the only debt my wife and I have is a mortgage on our house. Our emergency fund covers six months of both of our salaries.

Beware of rationalization
If you’re like me, when you get out of debt you will run into an interesting psychological problem: How now shall you live? You’ll soon find yourself with “extra” income, income that was before going to pay off debt. What do you do with this extra cash? How will it impact your spending? How will it affect your impulse buys? How will it affect your budget?

With freedom from debt comes more opportunity to rationalize. I was overjoyed when I became debt-free: I felt free for the first time in a long time. I felt like I had an increased ability to spend. I very nearly stumbled into old habits of acting on impulse and making unwise purchases. It was because I didn’t know what to do with my money. With no debt, you will begin to allow yourself to rationalize unwise purchases. “Well, I’m debt-free, and have the cash now, I could get that iPhone.” Or, even worse: “Now that I’m debt-free, I could get that big-screen HDTV with no interest payments until 2008″.

Set long-term goals
My advice is to first to set some more long-term goals, and to put yourself on a path to reach them. You’ve reached the “get out of debt” goal. But what now? How do you curb unwise purchases? For example, you might consider:

  • Do you want to retire early?
  • Do you want to put an addition on your house?
  • Do you want to pay for a child’s education?
  • Do you want to travel?
  • Do you love antique furniture?
  • Do you want to get your pilot’s license?
  • Want to start building that home theater?
  • Do you want to pay off your mortgage to become truly debt-free?

There’s not enough money to do every whim you desire, but by thinking about it, planning for it, then saving for it, there will be enough money to really do what you want in life. Set long-term goals that you want to accomplish. Incorporate them into your planning, and into your month-to-month budget. As with everything else, it is very helpful to automate long-term savings — it keeps you from cheating yourself. (Two goals I recommend highly are establishing a six-month emergency fund and planning for early retirement.)

Give yourself an allowance
“Ok”, you say to yourself, “these long-term savings ideas are all well and good, but how will this help curb my desire to spend unwisely? How will this make me feel like I’m free of money problems?”.

Slow down! You’re debt-free, but you will still worry about money, just in different ways, and for different reasons. You now have flexibility. It may seem like you’re on Easy Street now, but after a month you’ll realize you still can’t buy everything your heart desires. We all know this in our heads, but in our hearts I think there’s always a little voice saying, “Once I’m debt free, I’ll be able to get X, Y, and Z.”

I recommend giving yourself an allowance. Budget it. This works great for me, and it will probably work for you. You’re meeting your savings goals, you’re paying all your bills, you’ll be able to retire. And now when you have a desire or need (whether wise or unwise), you can debate using your allowance on it. Want a comic book? If you decide that’s what you want, go for it. No guilt. This will also help curb large unwise decisions. Want that cool new Nintendo Wii? Do you have enough allowance for it? Maybe not, but if you save for a couple of months, you can afford it. This method effectively accounts your whims, and allows you the feeling of being more able to do as you wish. It is a great feeling. 

As I said before, your money problems aren’t over. You will never have an allowance big enough to get every little thing you want. You will generally always feel like those big purchases are just out of reach. But ultimately this allowance will help you and keep you out of trouble — it will prevent you from spending money you don’t have.

Real-life example
As an example, here’s what my wife and I have done now that we’re debt-free. (I’m 27, we both work, no kids.):

  • We both contribute to our 401ks to get the company match. We’re taking care of retirement.
  • We have a budget to cover monthly expenses and a little buffer for the unexpected. We’re taking care of daily living costs.
  • We’ve set some long-term goals. I want to go back to grad school. We also want to purchase some nice furniture. It may be helpful to use multiple savings accounts to pursue multiple goals.
  • We give ourselves a monthly allowance. I use mine for video games. My wife has bought a few outfits she enjoys and doesn’t have to feel guilty about. She feels even better when she shops around to find great deals that fit in her allowance.

We finally are debt-free, and are learning how to live and feel free as a result. It wasn’t automatic — it requires continuing planning and awareness. But it is so worth it.

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