How to Pay Off Debt

Are you struggling with how to pay off your debt and can’t figure out what to do? You’re not alone. Millions of other Americans also struggle with credit card, mortgage, student loan and other forms of debt every day, and in this article we’re going to take a close look at the different ways you can work to pay off your debt as quickly as possible. It doesn’t have to be difficult or complicated. In fact, getting started can be pretty simple.

How to Pay Off Debt Faster: A Checklist

  1. Set up or reassess your household budget. Sit down and make a list that really looks at where your money is going each month. Be realistic and honest with yourself. You’re not doing anyone any favors by making things look better than they really are.
  2. Find places where you can make cuts. Figure out the difference between must-haves and nice-to-haves, and start eliminating the things you can live without.
  3. Look for extra income. Find things that you enjoy and see if there is a way to monetize these hobbies. For example, if you like interacting with people and enjoy being on the road, then you could become an Uber or Lyft driver in your spare time. Or, if you are handy around the house then you could offer up handyman services to others in the area.
  4. Use extra money to pay off debt. Once you have found extra cash – either by cutting your budget or earning extra money – make sure that you put it toward paying off your different debts.

If all of this seems intuitive and simple, it absolutely is. Many people, however, don’t make much progress paying down their debt because they never take these concrete steps. It’s important to go through the process of writing down this information if you want to make progress paying down your debt. It’s often the difference between success and failure.

Being stuck in debt can feel like a very solitary and embarrassing predicament. It’s hard to appreciate just how many of us are dealing with it. Let’s consider the big picture.

Debt In America

It’s no secret that Americans have a problem with debt. Many thought that things would change after The Great Recession. They didn’t. In fact, the average U.S. household now holds more debt than they did when the financial crisis hit. The New York Fed recently reported that debt hit $12.73 trillion in March 2017, surpassing the $12.68 trillion mark in 2008.

The biggest difference between now and then is how people are spending their money. Housing-related debt, which includes first mortgages and home equity loans, has actually decreased by nearly $1 trillion. Today, more of our debt is tied to student loans and auto loans. The increase in student-loan debt helps to explain the decrease in mortgage debt. As millennials graduate from college, large student loan payments are making it harder and harder to save for a down payment on a home.

 

Debt and Your Credit Reports and Credit Scores

The story isn’t all bad, though. Even with the sharp increase in household debt, credit scores have taken a turn for the better. For the first time since 2005, when FICO started tracking data, the average credit score reached 700. Plus, the number of borrowers with a credit score under 600 has decreased to 40 million individuals.

As we move toward the 10-year anniversary of the economic downturn, many people may start noticing changes to their credit reports and credit scores. For many people, bankruptcies and defaults will start dropping off credit reports, which should allow credit scores to rise even further. However, that could also mean more debt as people gain access to more credit. Anyone who has been turned down for a mortgage over the past decade will likely be looking to try again soon.

 

Using Debt Snowball vs. Debt Avalanche Methods

So, you realize that your debt is a problem, but where do you start trying to fix it? That is where many people struggle. Reversing debt requires two things: First, you need to effectively pay down what you currently owe and you need to make lifestyle changes, and second, the goal is to pay off your current debt, and keep it away for good.

What is the best way to eliminate the debt you have accumulated? Two very popular approaches are the debt snowball and debt avalanche methods. Each has advantages and disadvantages you should consider.

The debt snowball method is a great way to keep yourself in a positive mindset throughout the process. Here’s how it works:

  1. List out all of your debts from the smallest amount to the largest amount.
  2. You’ll pay the minimum payment on each and then put the remaining amount you’ve budgeted each month toward the lowest balance.
  3. Once you have paid off the lowest balance, take whatever that payment may have been and allocate it toward the next lowest balance.
  4. Do this until all of your debt is paid off.

The idea here is that by focusing on the lowest balances first, you will stay motivated, as you watch all your debts disappear.

However, some people will tell you that they would rather knock out the debts that have the highest interest rate first. This is where the debt avalanche method comes into play. Instead of focusing on the account balances, you will focus on the interest rates that you are paying. Here’s how the debt avalanche method works:

  1. List out all your debts like we mentioned for the debt snowball method.
  2. Instead of arranging them by their balance, arrange them from highest interest rate to the lowest.
  3. Pay the minimum balance on each and then put everything else toward the debt that has the highest annual percentage rate, or APR.
  4. Do this until all of your debt is paid off.

This method is likely to save you the most money, because you will be paying off your most expensive debt first.

“It is important for consumers to use the strategy that work best for them – there’s no one size fits all,” says Julie Pukas, Head of US Bankcard and Merchant Services at TD Bank. “If someone feels a real sense of accomplishment by eliminating smaller balances and that provides the motivation to focus on paying down higher-rate debt, then they should use that strategy. It’s really about what will allow a customer to set a strategy, see progress and feel accomplished as they reduce the amount of debt they have.”

When you use the debt avalanche method, you’re not going to get the little wins like you do with debt snowball, but you are going to pay down your most costly debts first, and if you stick to it, you’ll likely save more money. No matter which method you choose, you are going to be able to tackle your debt head on.

 

How to Pay Off Credit Card Debt

When it comes to debt, many experts frame it in two ways: good debt and bad debt. Mortgage debt is often considered a good debt because real estate often appreciates in value over time, helping to grow wealth. Student loans also can be thought of as a good debt because they can help you earn more income. However, credit card debt is not generally considered “good” debt and in fact, most people try to avoid it altogether. With the average credit card interest rate hovering around 16.6 percent as of July 12, 2017, the overall cost of an item can drastically increase when the balance isn’t paid in full each month.

Credit card debt is a major issue in America. In fact, the average U.S. household has an average of $8,733 worth of credit card debt, up 6 percent from 2015. If you do find yourself in credit card debt, then you need a solid plan of attack to pay it off as quickly as possible.

Two of the best ways are with the Debt Snowball and Debt Avalanche methods that we described earlier. But you can take those a step further and include balance transfer credit cards in your strategy. This approach entails applying for a new credit card with a lower interest rate than your existing cards and transferring existing credit card balances to that new card. Alternatively, if you have multiple credit cards and one of them has a significantly lower interest rate than the others, you can consider transferring all of your credit card debt to that card. However, there are a couple of things to watch out for when you consider using a balance transfer card to pay down debt. First, this card is not to be used for new purchases. It is only meant to help you pay down your current balance by lowering your interest rates. It’s also important to know that a balance transfer card isn’t going to be for everyone. Many cards will only approve borrowers with a good credit score. Finally, most balance transfer offers come with a fee. Borrowers are charged a percentage of the amount they are moving. Even with that fee, however, the benefit of the interest rate reduction may outweigh those costs. It’s important to pay close attention.

No matter which method you choose, you’ll want to pay down as much as possible each month. A recent study found that 29 percent of all credit card accounts regularly pay only the minimum payment each month. Not only will this extend the length of time you are battling credit card debt, but it will cost you more in the long run.

“Interest rates on credit cards are egregious. Paying just the minimum will take forever to get out of debt. The key is that you want as much of every payment as possible to go toward your principal and not toward interest,” says Scott Stratton, CFP®, CFA is the president of Good Life Wealth Management, a Registered Investment Advisor in Dallas.

Stratton goes on to recommend calling your credit card company when your interest rate is over 20 percent. Occasionally they will work with you by lowering your rate so they can keep your business.

 

How to Pay Off Mortgage Debt

As we noted above, mortgage debt is is considered good debt. Not only can your home appreciate in price, helping to boost your net worth, but interest rates are still near record lows. Even so, some people have an end goal of becoming debt free, which includes paying off the mortgage as quickly as possible. So how can this be done? How can you eliminate your mortgage faster than you thought, adding more disposable income to your pocket?

The easiest and most obvious way to accomplish this is to pay more each month. Instead of paying the standard 12 monthly mortgage payments each year, make 13 payments. By doing this you can pay off a 30-year mortgage in just 26 years, saving thousands of dollars in interest. Just make sure that you talk to your mortgage lender to make sure the extra payments are applied to the principal balance.

Alternatively, you could take advantage of historically low interest rates and refinance your mortgage. Instead of going with a 30-year mortgage, make the change to a 15-year or a 10-year loan, depending on the time you have remaining. While this will most likely increase your monthly payments, the total interest paid will decrease and your mortgage will be paid off sooner.

Plus, if you don’t have other high-interest debt then you could put any extra money toward your mortgage. If you receive a bonus at work, get a tax refund, or come into money from a windfall, then you can apply it to your principal balance.

 

How to Pay Off Student Loan Debt

At the end of 2016 there were 44 million student loan borrowers, accounting for a total of $1.3 trillion in student-loan debt. That number increased to $1.44 trillion in the first quarter of 2017. That is just in the United States. To help make that number a little more real, the average graduate in 2016 left school with $37,172 worth of debt, up 6.05 percent over the prior year. While many would consider student-loan debt a worthwhile form of debt, paying off student loans should be a priority when trying to become debt free.

One of the best ways to approach student-loan debt is to think of it the same way you would a mortgage. You can make larger payments each month to help reduce the balance and cut down the interest you will pay over the life of the loan.

Plus, depending on the interest rate you have, some will choose to refinance their loans with a company like Sofi or LendEDU. However, if you are planning to refinance federal student loans with private loans you need to weigh the pros and cons.

“You want to be very careful about consolidating or refinancing student loans because if you have federal loans, you may be eligible for benefits such as forbearance, income-based repayment, or even the Public Service Loan Forgiveness Program, which you might lose by consolidating to a private loan,” says Stratton.

Another great way to boost your student-loan repayment progress comes when you are searching for a job. Many public service jobs now offer loan forgiveness programs. However, it’s important to keep in mind that most of these programs have guidelines that need to be followed. Some companies will want you to work for them for a certain time period before the benefit is offered. Other companies will offer loan forgiveness from day one, but will require you to pay back the money if you leave before fulfilling a certain term of employment.

Consumer debt in America is a growing problem. With millions of people making payments each month on everything from their homes to student loans, something needs to be done to change the course of action. By providing the education and insight needed to fight back against debt, we are hoping to help make a dent in the $12.73 trillion personal debt balance that continues to grow each day.

[Editorial Disclosure: PayDownMyDebt.com is a service that provides people with tools to pay down their debts through automatic payments. The purpose of this article, however, is not to encourage users to purchase that service. This article is educational and journalistic in nature and aims to help people learn how to pay down their debt, whether they use our site, another, or go it alone.]