How to Get Out of Debt
Five tips to pay off debt faster
If you’re feeling like your debt balances are starting to weigh you down, you’re not alone. According to a recent study, 80.9% of baby boomers, 79.9% of Gen Xers and 81.5% of millennials carry some form of debt. NerdWallet reports that, on average, households with credit card debt owe $6,849 in revolving balances, and those with student loans owe $46,679.
Not only does debt tie up your cash flow with monthly obligations, finance charges can end up costing you hundreds, if not thousands of dollars each year - money that could be put towards other things such as an emergency savings fund and/or a retirement account. That’s why paying off debt is one of the most important steps in securing your long-term financial freedom. While paying off debt can seem overwhelming, following these five simple tips will help you get rid of debt in less time than you might think.
- Understand Your Total Debt
The first thing you need to do is make a list of all of your debts so that you clearly understand how much you owe. Keep in mind, debt is anything that you owe money on so make sure your list includes things like student loans, car loans, credit cards, medical bills, mortgages, home equity loans/lines, personal loans/lines of credit, etc. Your list should include outstanding balances, minimum payments due each month and the interest rates or APR that is charged for each balance.
- Create a Budget
Now that you know your total debt obligation, it’s time to create a budget so you know how much money you can put towards paying your debts each month. There are many budgeting methods you could use, such as the 50/20/30 rule or Pay Your Self First method, but in general, your budget should include a list of all income sources (paychecks, side hustles, etc.), how much you need for necessities (groceries, utilities, gas for your car, prescriptions, etc.), minimums due for all debt balances, a set amount to help you build an emergency savings fund, and a discretionary balance to spend on things you enjoy. Any remaining dollars should be put towards paying down your debt. If you find that you have little to nothing left after putting money toward necessities, minimum payments, emergency savings and discretionary spend, you should reevaluate your discretionary spend to see what you can cut back on.
- Don’t Create New Debt
Whatever you do, don’t create new debt obligations. Your efforts to pay off existing debt while creating new debt will be likened to running in a hamster wheel. You will never make any progress. Consider using cash for all of your discretionary spending. Once it’s gone, it’s gone. If you are tempted to reach for credit cards to pay for things, keep them tucked away in a safe (out of sight) place at home where you won’t have access to them when shopping.
- Determine Your Debt Repayment Strategy
Just as there are many ways to create a budget, there are many ways to approach paying down debt. What works for one person may not work for another. The important thing is to select a strategy that keeps you focused and motivated by the progress you make.
Paying Smallest Balance First
Using this strategy, you make all of the minimum monthly payments due on all of your debt balances. However, you will also use any extra money you have each month to attack the account with the lowest balance until it is paid off. Once it is paid off, you will redirect all the money that was put toward the lowest balance to the next highest balance (including the minimum payment you were paying on the second highest balance). This process will be repeated until all accounts are paid off. This process is coined the “snowball method” because as you pay off debt balances, the payment toward the next debt balance gets bigger and bigger.
Paying Balances with Highest Interest Rate First
Focusing on paying off the balances on accounts that are charging the highest interest rate first will help save you money on finance charges, especially if those same accounts have higher balances too. The same basic concept applies: put all your extra money toward the account with the highest interest rate (while also paying minimum payments due on your other balances). Once it’s paid off, shift all of those payments to the account with the next highest interest rate until all accounts are paid off.
While not taking on new debt is key to paying off existing debt, consolidating all of your existing debts into one account with one monthly payment is another good way to pay off debt quicker, particularly if the consolidated account has a lower interest rate. Consolidating your debt can happen through a variety of financial vehicles including loans or lines of credit from a financial institution, using a low-APR credit card, or even seeking out a debt consolidation service. However, discipline is key. It is important to stay vigilant in not creating new debt while paying off your existing consolidated debt balance.
- Take Advantage of Financial Windfalls
Regardless of the repayment strategy you choose, take advantage of any financial windfalls you receive to accelerate the debt repayment process. These include things like bonuses, birthday money, tax returns and inheritances. While it’s tempting to spend these windfalls on something you’ve had your eye on, your future self will thank you when your debt is paid off.
No matter how much you owe, making a plan, combined with a little bit of discipline, will help you get out from under the weight of debt before you know it. Doing so will not only ease your mind, it will also help secure your future financial success.