- Write down all of your debts
- Consolidate with a lower interest rate, where possible
- Cut expenses or increase income
- Pay off highest interest rate first
- Don’t accrue more debt
Write Down All Of Your Debts
You will want to write down all your debts or put them in an excel sheet. This way you can get a clear picture of what you owe and to whom. Include things like your minimum payment, interest rate, and payoff date. Once you have done that, you will be able to start building your plan for how you want to attack your debt and what takes priority.
Can You Consolidate At A Lower Interest Rate?
Where the possibility exists, you should move your debt over to other credit sources with lower interest rates. This can be done by using balance transfers, personal loans, and secured loans. The most important thing is you want your debt to be costing you as little as possible.
If you have a credit card costing you 22%, if you perform a balance transfer to a card that gives you 0% interest for the next year, you will have saved nearly a quarter of credit card debt just doing that. Make sure you look at the fine print though, and you don’t end up with a worse situation you had before.
Another option is a personal loan. If you can get a personal loan with a good rate, then you can consolidate your debts with a higher interest rate into that. This is a good option for credit cards and possibly student loans.
Quick point about student loans. Student loans may have a lower interest rate then what you are able to get with a personal loan. I would say for me personally, if I had subsidized ( non-dischargeable) student loans, I would consider rolling them over to a personal loan if the interest rate difference was within one percent. I would do that just for the peace of mind that if something went off the rails in my life, I could actually have my debt discharged rather than be saddled with a debt I cannot get rid of, even through bankruptcy. That’s a personal judgment call.
While I am not the biggest fan of using your home as collateral, another option is to use your homes value to your advantage. If you qualify for a better interest rate you can refinance your home and pull out extra to pay off your other debts. When you can get an interest rate under 3.5% this becomes a very attractive option.
You might be thinking “wait… isn’t that just kicking the can down the road?” Yes, if you choose not to make extra payments. However, if you treat that debt like you still have it and make additional payments on your mortgage, it is the same thing because money is fungible.
What you would want to look out for when doing this is that your monthly payment doesn’t change just because you paid down your mortgage faster. You can get saddled with a much larger mortgage payment for the next couple decades if you increase your loan amount by too much.
There are also Home Equity Loans and HELOCS available. These are secured by the equity in your home and the equity that you have built in your home belongs to the lender until you pay them back. If you do go this route, you want to make sure you have a fixed rate so you don’t get a nasty surprise, if interest rates start to climb.
With all of these methods it is important to factor in fees, and if you aren’t getting a much better interest rate, then consolidation could cost you more money than you are saving. You do not want that.
Cutting Expenses
Cutting expenses is the most important thing you can do when it comes to paying down debt. After all, debt is expenses you weren’t able to pay for to begin with. That is why setting a good budget is key, and you need to live below your means. You can really turbo charge your ability to pay off debt if you are willing to sacrifice some comforts.
One of the best ways you can really pay down fast is by moving in with family or by getting roommates. Housing is likely the biggest bill you are paying for right now. It might not be fun to share a space, but if your willing, then being able to put an extra $1,200 a month toward debt can really start chunking away debt fast.
The next best way is to look at the things you purchase everyday. These are the small transactions that fly under the radar. Because in the moment they seem relatively cheap, you barely notice $5 here, $4 there. However, when you add them up they they can become huge!
Do you have a designer coffee habit? If you are paying $5 a day for that coffee, at the end of the month you will have paid $150 on coffee. You could purchase your coffee somewhere else for cheaper, maybe save 20% and save $30 a month, That’s a good savings. The best is going to be making that coffee at home, and you can make something just as good if not better. You could save 80% or more just doing that, That’s a $120 you can apply to your debt coming only from your coffee bill!
When it comes to your groceries be willing to shop around at multiple stores, and hunt for deals. On any given week, a ribeye steak might cost $13 a pound, but if you wait for a sale, you can pick it up for half that. You should also look at purchasing non-name brands, often they taste just as good, but are a faction of the cost.
When it comes to groceries and other small to medium purchases such as, clothes, take out, and home décor I apply 2 mental tricks. With these I am able to convince myself to press pause on the purchase button.
Increase Income
This is the method we would all prefer. The problem is you need to work more hours. Whether that is at your current job, or by starting a business. If you are already stretched to the max between family and work this might not be feasible, that is why controlling expenses is so crucial.
If your job isn’t cutting it then maybe it is time to ask for a raise or start applying else where. You should always try and get the best deal you can for yourself because your time is valuable.
Starting a business is great, and I highly recommend it, but it might be a while before you receive an income. You want to be careful not to get yourself in even more debt because of start up costs.
Why You Should Pay Off Highest Interest First
Paying off your highest interest rates first will save you the most money on your debt, when compared to other methods such as the snowball method. It does this by removing your most expensive debt first, rather than removing the lowest account balance.
You only get to pay off so much debt at a time! Imagine you have a $1,000 dollars to pay down debt. Would you rather pay down the debt that is going to cost you $120 dollars over the next year? or the one that is going to cost you $80? You will have saved an extra $40 if you pay down the 12% debt before the 8%.
While the snowball method is great, and will get to your goal. It does not save you as much money as paying off the highest interest rates first. The snowball method has 2 advantages. One, it can keep you more motivated by allowing you to cross off a debt sooner. The second, it will decrease your overall minimum debt payment. This is the payment that is needed to pay the minimum payment on all your debts.
Lets say you you add up all your minimum payments (excluding your home), and it comes to $900. By removing one of your debts, you will remove a payment, and you can lower that to $700. This is good for financial flexibility, and if you have a bad month, the minimum money you need to come up with is lower. However, going after the lower account balance first could cost you more in the long run a interest payments.
It is also likely that these two methods will end up having the same pay off order because how we accumulate debt.
Don’t Accrue More Debt
Avoid adding debt at at all cost. If you continue to add debt while you are trying to pay it down, you will be on a never ending debt treadmill. The goal should be to get out of debt, and to stay out of debt for good.
Don’t make plans based on future income. Example, when you are thinking about buying something on your credit card, stop! Make sure you can pay for it, right then, with the money in your bank account. You never know when you will get hit with random expense and you will be forced to carry a card balance.
Have an Emergency Fund. Repairs, work absences, and other life challenges will come up and you need a pool of money you can draw from without borrowing.
Live within your means. Example, having a nice car is great, but the satisfaction will not last long. Your car payment however, will stick around. This doesn’t mean you have to drive a car from the 90’s that you pick up for a few hundred dollars. It means to look for a quality car that meets your needs, will not cost a lot in repairs, and that you afford. Preferably paying for in cash.
Continually Budget. Be aware of your financial situation. Know how much you are spending and how much you are making. Here is a free paycheck budget and monthly budget PDF template I made.
