how to pay off debt

How to Pay off Debt

Debt gets really a bad rap but the reality is that, for most consumers, carrying around some level of debt is unavoidable. Few of us can afford to buy a home or even a new car with cash, and paying for a college degree without a student loan or two (especially at a for-profit university) is uncommon.

With that said, holding as little debt as possible should always be the goal, for the sake of your budget, your credit, your future plans, and even your sanity. And knowing how to pay off debt in the most efficient way possible can save you both time and money along the way.

Why getting out of debt is so important

There are many reasons you should try to eliminate as much of your debt as possible. Here’s why it’s imperative to pay off your balances as soon as you can.

It’ll benefit your retirement plans

Successfully planning for retirement requires serious saving, budgeting, and reducing your living expenses in the years before you retire. 

If you’re still in debt, though, you need to ensure that your retirement savings are able to cover those monthly payments, too. The less of your income you need to allocate toward debt repayment, the less you need to save for a successful retirement… making retirement easier if you’re debt free.

You’ll save money

Being in debt affects your budget in two ways. First, you’ll need to dedicate a certain portion of your income to monthly payments on those balances, which eats away at your available money each month. The sooner those debt balances are eliminated, the sooner you’ll have more flexibility in your budget, which you can dedicate to things like savings.

Second, it’s important to remember that most debt comes at a cost, usually in the form of interest (or finance charges). The longer it takes you to pay off your balances, the more you’ll pay in interest over the course of the repayment.

Your credit score will improve

Paying off debt — or even just a portion of it — can help improve your credit considerably. 

Lower account balances equate to a lower credit utilization, or how much of your credit limit you’re actually using. Not only will your credit utilization decrease, though, but you’ll also reduce your overall debt-to-income ratio, giving your credit score a boost in the process.

You’ll get better terms on future credit

The less debt you carry, and the better your credit score, the better the interest rate and loan terms you’ll be offered down the line. This means you’ll save money on future borrowing, whether you need a personal loan or home loan down the line.

You’ll help your mental health

Debt plays a large role in your emotional health and stress levels. In fact, a recent American Psychology Association survey found that 72% of US adults have felt stressed about money in the past month. 

When you pay off your debt — or at least lower some balances — it can have a tremendous effect on your stress levels.

You’ll access better financial products

Whether you need a new mortgage, want a lucrative rewards credit card offer, or are interested in refinancing existing loans at a lower rate, a lower debt burden will open the door to the best financial products, services, and offers.

How to pay off debt

So, now that you know the benefit of being debt free, how exactly do you go about paying off your debt?

Step one: Find out what (and how much) Debt you have

The first thing you should do is pull all of your statements to figure out exactly how much you owe, and to whom. This includes gathering your credit card statements, student loan balances, auto loans, mortgage debt… all of it.

Next, add up those balances to determine what you owe today. You may also want to look at your credit report to ensure there aren’t any balances you owe elsewhere, or accounts you’re forgetting.

Step two: Separate debts by category

Not all debt is created equal. 

Whether your goal is to be 100% debt-free or you’re okay with carrying a home mortgage, the simple fact is that some balances should take precedence over others. This could be because they:

  • Have a higher interest rate
  • Have a higher credit utilization (your balance is too high compared to the account’s overall limit)
  • Require too much of a monthly payment

Generally, you should first focus on credit card debt, personal loan (including educational) debt, and auto loans when working to pay off your debt. These types of debt tend to have the highest interest rates and will cost you the most in the end, so getting them paid off first is wise.

To be entirely free of debt, you would need to pay off debts such as home loans and auto loans. However, many consumers would argue that mortgages — with their decades-long repayment terms and low interest rates — don’t fall into the same category as other consumer debts. Some would even say that mortgages are a necessary evil.

However you feel about your personal debt situation, spend some time deciding which balances are priority in terms of a repayment plan.

Step three: Set a budget

Your next task, once you’ve calculated how much debt you have and where the hierarchy falls, is budgeting.

Your debt payoff plan will rely largely on what you can afford to contribute to the cause each month. You should first figure out how much of your money is already earmarked for household expenses — such as rent, food, insurance, and other necessities — and what you can dedicate to debt payments. 

At this time, you can also start thinking just how aggressive you want your debt management plan to be. Are you willing to forgo “fun” expenses for a year or two while you attack your debts? Or can you only contribute a bit more than the monthly minimum payment?

It really comes down to personal preference and just how serious you are about debt payoff. The more money you can throw at your credit card debts and other balances, the sooner you’ll get out of debt.

This might mean finding sources of additional income, on top of saving more of what you already make. For instance, you could take on a new side hustle to bring in a few hundred extra dollars each month, then dedicate all of that to your repayment efforts. 

Step four: Come up with a payment plan

Now that you know how much money can go toward your debts, it’s time to create a debt strategy.

There are two popular debt repayment approaches to consider: the debt snowball method and the debt avalanche method. Each of these involve focusing on one specific debt balance, while making the minimum payment on all other accounts. 

With the debt snowball, you put all of your extra money toward paying off the account with the largest balance. Once it’s paid off, you focus on the next highest balance, and so on. With the debt avalanche, you focus first on the account with the highest interest rate, paying off that balance before moving on to the next highest interest rate.

Whichever debt management plan you choose — or whether you create your own strategy — you absolutely need to have one. Paying off debt can be tricky and even overwhelming at times; having a strategy keeps you focused, in control, and helps you save time and money along the way.

Step five: Consider refinancing certain debts

In many cases, refinancing certain loans and lines of credit can be a great way to attack your debt more effectively. This will often help you get out of debt faster and save money on interest in the process.

Refinancing can unlock lower interest rates that what you currently have. For instance, if your credit score has improved or market rates have dropped, refinancing an auto loan or home mortgage can help you lock in a better loan term, a lower interest rate, and even lower your monthly payment. You can then use the savings to pay off other debts more aggressively, too.

Interest charges on credit card debt are often some of the highest around. You can “refinance” these balances by either taking out a consolidation (personal) loan, or by moving the debt to a card with a 0% balance transfer offer. While the introductory rate on balance transfers will usually only last around 12-24 months, this gives you an opportunity to pay off some debt without accruing new interest.

You could also consolidate educational loans to lock in lower rates and simplify your repayment efforts. Rather than tracking multiple accounts, each with their own payment amount and due date, you would have only one account to track each month. 

Step six: Automate the process

Once you have a plan in place, try to automate as much of your debt repayment efforts as possible. This saves you from needing to submit each payment and track every account manually.

Automating payments helps you in two ways. First, it prevents errors, such as accidentally making late payments on your credit card or missing a mortgage payment. Late payments could result in extra fees, a penalty interest rate, and can even damage your credit scores. It’s important to pay on time, every time.

Second, automating can help you avoid potential poor choices. It could be easy to abandon your debt repayment efforts one month, for instance, if you encounter an unexpected expense or want to have a little fun. 

Rather than pay double on a credit card balance, you might choose to go out to dinner with friends, which could sabotage your efforts. If your payments are automated and calculated in your budget, though, you already know that the money is spoken for.

Step seven: Avoid taking on new debt

If you want to be successful in your debt repayment efforts, it’s imperative that you identify bad spending habits and avoid taking on new debt along the way. 

Paying off your credit card balance is nearly impossible if you’re continuing to add new charges to the account, for instance. And if you use a balance transfer offer to clear a card balance, only to turn around and run up that empty credit card’s balance up again, you’ll end up in an even worse place than before.

Spend some time looking at your personal habits and how they impact your goals. 

For some people, this could mean temporarily hiding credit cards or literally cutting them up, to avoid the temptation of spending. If needed, implement some new rules for yourself, make a firm budget, and even consider whether a financial coach could be beneficial.

Bottom line

Finding yourself in debt — whether we’re talking about credit cards, personal loans, student debt, or auto loans — is much easier than most people expect. Add in compounding finance charges on credit card debt, for example, and it’s simple to understand how folks can wake up one day in more debt than they know what to do with.

Getting out of that debt, though, takes a much more intentional approach.

Knowing exactly what you owe, and to whom, is priority. Then, developing a plan for getting out of that debt in the quickest, most effective ways possible — and sticking to said plan — will be imperative to your success.