Americans carry a lot of debt. According to Northwestern Mutual, the average American has $38,000 in non-mortgage debt. Credit cards and mortgages are the primary sources of that debt, followed by student loan debt and car loans.
Having any debt at all is not ideal, but it’s important to remember that not all debt is necessarily “bad” debt. Good debt can be considered an investment that will generate future value.
For example, some people consider student loan debt to be good compared to other types of debt because the interest rates on student loans are relatively low and a college education can boost a person’s long-term earning potential. The same can be said for home loans, since real estate tends to appreciate in value over time.
On the other hand, credit card debt can be considered bad debt. Credit card debt comes with high interest rates, and it usually indicates unhealthy spending habits.
But regardless of whether your debt is good or bad, it’s still important to pay off debt in a timely and efficient way. When you escape from the burden of debt, you can start thinking about other long-term financial goals, such as retirement or your children’s education.
Here are some strategies and tips for paying off your debt and improving your personal finances.
In this guide:
- Step 1: Figure Out How Much You Owe
- Step 2: Identify the Types of Debt You Carry
- Step 3: Choose a Debt Payment Plan
- Tips to Pay Off Debt Faster
Step 1: Figure Out How Much You Owe
Before you can strategically work to pay off debt, you need to figure out what you really owe. You may not have tallied up your debt before, and it can be tough to swallow in some cases, but being honest with yourself is the first step to paying off all that debt.
A few tips for figuring out your debt:
- Read your credit report. Your credit report will tell you about all of your outstanding debt as well as any collection records you may have. You can also see your initial credit score, and then track your progress as you pay off debt.
- Gather all of your credit card statements. While your credit report shows you your credit card debt, it’s usually a few months behind what you actually owe.
- If you have any questions or you’re unsure of what you owe, call your creditors directly.
- When checking your outstanding balances, you want to note the total, but you also want to record all of the individual interest rates for each balance you carry. You’ll use these rates in step 3.
Step 2: Identify the Types of Debt You Carry
There are two main types of debt — fixed and revolving.
Fixed debt comes from mortgages, auto loans, personal loans, and small business loans. With these loans, you borrow a fixed amount of money with a fixed interest rate, and you’ll repay it in equal payments over an agreed repayment term.
If you have fixed debt and you pay it off on schedule, it can show borrowers you’re reliable and boost your credit score.
However, if you can pay off fixed loans earlier than required and the lender doesn’t charge a prepayment penalty, you can save on interest payments.
Revolving debt, on the other hand, comes from lines of credit, such as a credit card or HELOC. When you have revolving credit, you pay off only what you use, and your interest rates may be fixed or variable. The size of your payments will be based on the total amount you owe at any given time.
Generally, if you’re going to focus on paying off one type of debt before the other, work toward paying down revolving debt.
The interest rates on revolving debt are almost always higher than fixed debt, and the rate can potentially go up anytime.
Also, having too much revolving debt can adversely impact your credit score. If you want to borrow money in the future, it may be more difficult and more expensive if you have a high amount of unpaid revolving debt.
Step 3: Choose a Debt Payment Plan
Once you have a clear idea of how much you owe, the interest rates you’re facing, and the type of debt you carry, you can start creating a plan for prioritizing payments.
There are two primary debt payment plans to choose from: the debt avalanche method and the debt snowball method. There are also other options that can help as well, including debt consolidation loans and balance transfer credit cards, which we’ll get into below.
The Avalanche Method
Mathematically, the debt avalanche method is the debt repayment option. It will help you pay off your debts in a shorter amount of time and it will save you the most on interest.
The avalanche method requires that you target your highest-interest-rate debt first, since that’s costing you the most money.
To put an avalanche plan into place, you should list out each debt you need to repay. Prioritize them with the highest interest rate debt first, then move down to the lowest interest rates.
Next, make a note of the minimum required payment for each balance. You should make sure you’re always paying this amount on all debts to avoid late payment fees and further damaging your credit score.
Once you know each minimum payment is settled, figure out how much extra money you can put toward that first balance with the highest interest rate.
For example, if you have a student loan with an interest rate of 5%, an auto loan with an interest rate of 9%, and credit card debt with an interest rate of 19%, the 19% debt is the priority. Make sure you can afford the minimum payment required by each lender, then put all of your spare cash toward that credit card balance (except, of course for an emergency fund in your bank account, or money you need for groceries).
Continue doing this for as many months as it takes to pay it off. Once it is, paid off, you can then add all of the cash you were dedicating to paying off your credit card debt toward the next highest balance — your auto loan.
Depending on the size of each debt balance, the avalanche method may sometimes feel like the slower way to pay off debt. It won’t feel as gratifying as immediately knocking out small balances you carry elsewhere, but it helps you save money on interest, which is what you’re trying to accomplish by paying off your debts.
The Snowball Method
The snowball method is based on the concept of paying off the smallest balance first before moving on to larger goals.
Using this approach, you should still make sure you’re submitting the minimum payment required by each debt.
Next, you would apply your extra cash to paying off the smallest debt first; then you would roll what you used to pay that balance off into paying off the next debt on the list, and so on.
The focus of the snowball method isn’t about saving money on interest. It’s about short-term gratification and small victories that can keep you encouraged and on track. If you’re worried about your ability to stick with your plan, psychologically, the snowball method might be a good fit for you, even though it could cost more than the avalanche method.
A third option that you can use to tackle debt is debt consolidation. The concept of debt consolidation is combining multiple debts into one new loan. Then you only have one payment to worry about, so you can stay on track with your payments.
Although consolidating debt can simplify your debt, it will only be beneficial if the consolidated interest rate is lower than the average rates you paid previously.
The two main ways to consolidate debt are debt consolidation loans and balance transfer credit cards.
Debt Consolidation Loans
Debt consolidation loans are a type of debt refinancing. You replace your existing loans with one single new loan, so that repayment is easier. Ideally, the new loan should have a lower interest rate than the original rates you were paying, and you should try to stick to a repayment plan that gets you debt free in the same amount of time — if you can afford the monthly payments.
Balance Transfer Credit Cards
Credit cards, with their expensive, revolving debt, may be what got you into this mess in the first place. However, balance transfer credit cards are designed specifically for people with large outstanding balances.
Typically, these cards come with a 0% APR period. This period usually ranges from 12 to 15 months and sometimes even 18 months after opening an account. If you transfer your debt to one of these cards, you can spend those months paying down your debt interest-free. If there’s still a balance remaining at the end of that period, you can transfer it to another card or debt consolidation loan to pay off the rest.
You should be wary of a couple of things, though. First, you want to make sure you don’t leave a balance on the card after the 0% APR period ends, as credit card interest rates are prohibitively high.
Second, be aware that most cards do charge a 3% to 5% balance transfer fee, so if you’re transferring a large amount, you should look for a balance transfer card that waives that fee, such as the Amex EveryDay Credit Card.
Bankruptcy is the final option that should only be considered as a last resort after all other debt repayment options have been explored. Bankruptcy is challenging to enact and can ruin your credit for years into the future.
>> Read More: Debt consolidation vs. bankruptcy
However, if you’ve found yourself in a situation where you’re buried by debt that you can’t repay, bankruptcy may be the only viable option for you.
There are two main types of bankruptcy—Chapter 7 and Chapter 13.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is also referred to as straight bankruptcy or liquidation bankruptcy. In this scenario, a court-appointed trustee is in charge of your case. The trustee takes your qualifying assets, sells them, and distributes the money to pay creditors who file valid claims. You can keep exempt property, however, such as money saved in your 401(k).
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is similar to chapter 11, which is for businesses. With these types of bankruptcy, the petitioner, who is the person filing, creates a plan to protect assets such as their home from foreclosure and then asks for forgiveness for other debts. This is the less extreme option compared to chapter 7 which requires liquidation of nearly all assets.
Tips to Pay Off Debt Faster
It’s easy to be discouraged when you feel like you’re facing a mountain of debt. It can feel overwhelming and like it’s stopping you from making progress in other areas of your life. However, if you can create a plan and stick with it, it can help you feel better mentally and also organize your goals to chip away at that debt.
Also, both debt repayment plans mentioned (avalanche and snowball) indicate you ideally need to put extra money toward one payment a month. Even a small amount over the minimum is better than nothing. The following are some good ways to pick up extra cash that you can use to pay off debt:
- Cancel Your Subscriptions. Go through and cancel as many subscription services as you can. If you do an audit of your subscription services, such as Spotify, Netflix, and Hulu, you may find unnecessary spending in the hundreds of dollars. Cancel those services and put that money directly toward paying off your first debt. You can also put a hold on subscription services in many cases, and resume use once you’ve made some progress toward your debt payoff goals.
- Hold a yard sale. Gather up and sell things you no longer use. You can sell your items at home or online on a site like eBay or Poshmark, and each sale that you make should go directly toward your top-priority debt payment. Who knows, maybe decluttering your home may encourage you to clean up your finances, also.
- Look for side gigs. You can drive for Uber or Lyft, work for a delivery service or pick up freelance work on sites like Upwork. Even a little spare change, applied to a debt over the course of months, can make a big difference.
The Bottom Line
Knowing you’re in debt isn’t a great feeling, but taking control of that debt, being aware of what you owe and being strategic in how you pay it off can not only save you money but also provide peace of mind. Organize your payments, then look for little ways to become debt free faster today.