Debt Consolidation

Creating a Plan to Become Debt-Free

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There’s plenty of cookie-cutter financial advice out there: Earn more money. Cut up your credit cards. Eat out less. Make coffee at home. These kinds of tips are obvious and, at times, may not be helpful. So before you cut up your credit cards, explore these realistic strategies on how to get out of debt.

Do this first: Identify your target debt

Before you choose a debt repayment strategy, become familiar with your financial obligations and which you want to repay first:

  • Credit card debt
  • Student loan debt
  • Auto debt
  • Mortgage debt
  • Medical debt
  • Tax debt

This is important because some types of debt will open new doors for your debt repayment strategy. For example, you may be able to negotiate medical debt or tax debt. With mortgage and auto debt, you could consider refinancing. If you have credit card debt across multiple accounts, you could consolidate.

If you’re not sure which debt to pay off first, consider such things as each debt’s APR, their outstanding balance and how important it is to you to pay them off. In general, paying off the debt with the highest APR is your best bet for saving money, especially if you’re locked into your terms and can’t refinance for better terms.

That said, you don’t have to do everything optimally. If you’d be more motivated repaying your debt with the lowest balance or knocking out your federal student loans (no matter the borrower protections), then you can make that decision.

5 strategies to become debt-free

  1. Pay off your highest-interest debt first
  2. Pay off your smallest balance first
  3. Set your own goal with a debt payoff calculator
  4. Meet with a debt counselor to form a repayment plan
  5. Consolidate debt with a personal loan or balance transfer credit card

1. Pay off your highest-interest debt first

The debt avalanche method involves paying off your debt with the highest interest rate first, and working your way down from there. For example, you might consider paying off debt in this order:

  • 25% interest store credit card
  • 22% interest rewards credit card
  • 7% interest auto loan
  • 6% interest student loans
  • 5% interest mortgage

This way, you’re paying less in interest charges over time. In the meantime, you’ll continue making minimum payments on your other debts — you’ll just be allocating extra cash toward your priority debt.

2. Pay off your smallest balance first

Tackle your debt in baby steps using the debt snowball method. You’ll target your debt with the lowest balance first while making the minimum payment on your other debts. Once your low-balance debt is repaid, you’ll move onto the next debt.

This repayment method helps you cut down the number of debts you owe and gives you small wins to keep you motivated on your repayment journey.

Using the same example above, try the exercise with debt amounts:

  • $1,000 rewards credit card debt
  • $1,500 store credit card debt
  • $10,000 auto loan debt
  • $35,000 student loan debt
  • $150,000 mortgage debt

Compared to the above example, you’ll notice that this list didn’t change much. That’s because low-interest debts like car payments and a mortgage are paid over a longer period of time than credit cards, which would ideally be paid off monthly.

3. Set your own goal with a debt payoff calculator

Utilize an online debt payoff calculator to determine how much you should allocate toward your debt in order to pay it off within a certain time frame.

Let’s say you set a personal goal to pay off your $2,500 credit card debt in 2020. Online debt calculators let you plug in your debt, interest rate and payoff date. Based on that information, you’ll have a goal monthly payment. Here’s what that looks like if you have a store credit card and a rewards credit card using the examples above:

This gives you a clearer image of how much you’ll pay every month, and how much you’ll pay in interest in the long run. You might even decide that you can pay off those credit cards earlier to avoid accruing more interest. Try six or eight months, if you can.

The best part about utilizing a debt payoff calculator is that you can customize your strategy to pay off debt based on how much you can put aside each month.

4. Meet with a debt counselor to form a repayment plan

Debt counseling, also known as credit counseling, is when you meet with a certified credit counselor who will:

  • Offer money and debt advice
  • Help you set up a budget
  • Give you educational materials on money management

Credit counseling organizations are primarily nonprofits that offer low-cost or free debt counseling. Depending on your circumstances, a counselor may set you up on a debt management plan, which sets a clear timeline for your debt repayment. Debt management plans come at a cost, typically a monthly fee.

You can find a certified credit counselor by searching the National Foundation for Credit Counseling or Financial Counseling Association of America.

5. Consolidate debt with a personal loan or balance transfer credit card

If you’re struggling with debt, you might consider debt consolidation so you can repay your dues with a better interest rate. This repayment method also allows you combine multiple debts into one, allowing you to make just one monthly payment instead of multiple payments.

There are two popular ways to consolidate your debt: Opening a personal loan or a balance transfer credit card. The catch: Both of these debt repayment options may be out of reach for those with lower credit profiles. You’ll have a hard time securing a good rate on a personal loan with bad credit, and you’ll find it difficult to qualify for a balance transfer credit card without a good credit score.

If debt consolidation seems like the right money move for you, compare your options below.
best way to get out of debt

Building debt repayment into your budget

debt free living

50/30/20 budget: Allocate part of your income to debt

The 50/30/20 budget was promoted by Mass. Senator Elizabeth Warren in her 2005 book “All Your Worth: The Ultimate Lifetime Money Plan.” It works like this:

  • 50% of your budget should go toward your needs, like mortgage or rent, utilities, healthcare, groceries, transportation and childcare.
  • 30% of your budget should go toward your wants, like entertainment, dining out, cable and internet, shopping and travel.
  • 20% of your budget should go toward savings and paying off debt, like credit cards and student loans.

Under this rule, you should be paying a good chunk of change toward your debt each month. If you have the willpower, you could even try flipping the 20% and 30% so that you can put more toward debt repayment, or even try something closer to 50/25/25.

Zero-based budget: Account for every dollar earned

Zero-based budgeting is a method in which your income minus expenses equals zero. In other words, you are accounting for every dollar of income you bring in each month, even savings and debt payments, so you have $0 leftover at the end of the month.

Let’s say you bring in $4,000 per month after taxes, retirement and healthcare are taken out of your paycheck. Your budget might look something like this:

There’s nothing leftover at the end of the month because whatever isn’t classified toward utilities, bills and other costs is put aside into savings or used for debt repayment.

Envelope budget: Put exactly enough aside for each spending category

Get out of debt the old-fashioned way by utilizing the time-tested envelope budget. Here’s the general idea of this budget:

  1. Label envelopes for each spending category, such as dining out, utilities and groceries.
  2. Estimate how much you’ll spend monthly on your expenses, and put a set amount of cash in each envelope.
  3. Use this cash to pay for the expense throughout the month.

While it’s tedious to do this month after month, you might consider trying it for a few months simply to get a better idea of where you spend your hard-earned money. For example, you may find that you spend more on groceries than you had budgeted for, or you could learn that you’re spending more on going out to the bar than you realized.

Live small: Cut regular expenses to maximize savings

Whether job loss, a financial misstep or something else landed you in debt, it can be exhausting worrying over money and juggling bills. For some people, minimizing regular expenses may be the best approach to taking control of debt. That could mean downgrading to a more modest home or car and putting the savings toward debt or into an emergency fund.

This strategy could also entail seeking out more affordable phone plans, auto insurance or other monthly services. Canceling a gym membership and picking up running, for example, could save you money until you’re in a more comfortable financial situation. 

Although it can take hours to shop your options, cancel old services and sign up for more affordable ones, minimizing these recurring expenses can help accelerate debt repayment. And once the work is done, you can reap the benefits each month.

Don’t neglect your emergency fund

It’s important that you don’t sacrifice your emergency savings for debt repayment. You should always be saving at least some money in your emergency fund. That way, when you’re hit with a big, unexpected expense, you don’t need to resort to taking out debt again.

Many professionals advise that you have between three and six months worth of expenses saved up in case an emergency occurs. If that seems like a lot, start small; make your emergency fund by saving up one week’s worth of expenses, then one month, and build up from there.

Creating a safety net ensures that you won’t go back to square one by taking out more debt than you can pay back.

 

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