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How To Pay Off Debt: A Complete Guide

4-Minute Read

We don’t need to wonder about the romance and fun of credit card spending. Every day, we’re shown images of happy people making priceless memories armed with nothing more than their small plastic card. Who doesn’t want to make dreams come true for themselves or loved ones?

But we all know that once the high of spending is over, the hangover of debt sets in. The good news is, becoming debt-free is within your reach.

Calculate Your Total Debt And DTI

The first step you’ll need to take is to sit down and add up all your debt. Next, calculate your debt-to-income ratio, or DTI.

Create A Budget And Stop Creating New Debt

If you’re serious about getting out of debt, you have to create a budget so you know where every dollar you earn is going. To do this, you’ll need to figure out exactly what you must spend – on food, utilities and transportation – and divert every other dollar into reducing your debt.

But be realistic. Don’t plan on reducing your food bill by eating only boxed macaroni and cheese for dinner from now on. If you eat out every night, start grocery shopping, but give yourself one night of takeout a week as a treat. If you buy a $5 cup of coffee twice a day, maybe limit yourself to one coffee every other day. If your budget suddenly becomes draconian, you won’t stick to it for very long, and you’ll likely end up back on the debt treadmill.

Save For A Rainy Day

Part of your new get-out-of-debt budget should go toward increasing your emergency savings account. No, the interest you earn on that account won’t be more than what you’re paying on your credit card debt – but having at least some money tucked away will give you some security in our uncertain world.

In time, you’ll want to beef up your monthly savings, but for now, even a token amount deposited without fail will set up good saving habits for the future.

Image of phone calculator.

If Your DTI Is 36% Or Lower, Try These Debt Hacks

If your DTI is excellent or good, but you’re still uncomfortable with the amount of debt you’ve accumulated, consider some of these debt hacks to work your way to zero balances.

Consider Biweekly Payments

You can pay off your debt by paying every 2 weeks instead of every month. You’ll end up making the equivalent of one extra payment each year. When you pay off debt with a biweekly payment, you shouldn’t see a dramatic change to your monthly expenses. However, you’ll see dramatic savings as you pay off debt over the years because you're reducing the amount of interest.

Send Extra Money

Yes, it’s as easy as that. All you need to do is to make an extra payment – however much you wish – whenever you can. If you find it hard to remain disciplined and scrounge up money here and there to shovel toward your debt, you can consider sending small recurring payments toward them.

Don’t forget that if you do so, make sure you let your lender know that the extra payment is to go toward the principal of the loan. That way, your lender will contact you if you need to do things differently to make extra payments. Besides, making payments toward the principal means you’ll pay less in interest.

Getting a tax refund or work bonus this year? That check can come in handy for those early payments.

Round Up Loan Payments

Even though what you get may seem like small change, rounding up payments is a great start to paying more toward your debt. You don’t need a ton of extra cash, and you probably won’t notice the amount, given that it’s so small.

Next time you make your payment, just round it up to the next couple of dollars. For example, if your credit card payment is $112.23, add an extra $7.77 to make it $120. Within a year, you’ll have paid an extra $93.24.

Ask For Discounts

Some lenders offer rate discounts if you sign up for autopay or online bill payments. Some even do so if you opt for paperless statements. It never hurts to ask your lender whether your payment history qualifies you for a lower rate. Even a fraction of a percent off your interest rate can make a huge difference in how much you’ll save.

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If Your DTI Is Between 36% – 50%, Attack Your Debt Aggressively

If your DTI is hovering around 50%, you’ll need to get more aggressive about eliminating your debt.

Make A Debt Snowball

The idea behind the debt snowball is to rack up some quick wins and gather that momentum into a debt-free lifestyle. It works like this: You organize your debts from smallest to largest, without regard to interest rates. For all debts except the smallest, you pay the minimum amount due. For the smallest, you throw everything you have at it, until it's paid off.

When it is, feel free to reward yourself with your favorite takeout dinner or another one of those fancy coffees you enjoy. You’ve earned it!

Create A Debt Avalanche

Another approach is the debt avalanche method. Avalanchers recommend organizing your debt by highest interest rate to lowest, and attacking your most expensive debt first. Financially speaking, this makes complete sense, because you’ll save money long-term by getting rid of your most expensive debt, but you do forgo the quick wins that you might need to keep you motivated.

Loans that tend to have the highest interest include payday loans and credit cards. Loans like federal student loans or your mortgage tend to have lower interest, meaning it’s OK to hold on paying them off early for now. Plus, federal student loans offer programs like loan forgiveness or income-based repayment plans, which can lower or eliminate part of your debt.

Gather Debt Snowflakes

The newest entry in the snow metaphor series is that of the debt snowflake. The idea behind debt snowflakes is that you divert any amount of found money toward your debt goal. For example, if you find a $5 dollar bill emerging from the melting snow, it goes toward your snowfall or avalanche target. The idea is that those micro-amounts add up more quickly than you might think, and thus can help you reach your goals faster.

Consolidate Your Debt

Debt consolidation is a great way to simplify your debt and save money at the same time. Consolidating your debts means that you take out a debt consolidation personal loan to pay off your higher-interest credit card debt. You’re then left with one loan payment at a fixed, and usually lower, interest rate.

The idea is that debt consolidation makes it cheaper and more convenient to pay off your debt. It also allows you to plan your budget around a payment that won’t vary unless you choose to pay extra to pay the loan off faster.

Here’s the catch: Unless you actually stop the bad spending habits that got you into debt in the first place, you’ll just keep digging yourself deeper into a hole. If you start using your credit cards again without paying off your balance in full every month, you’ll end up worse off than you were before.

Debt consolidation works well if you accumulated the debt because of a one-off event, like a medical or car repair emergency.

Stay Cautious With 401(k) Loans

In extreme circumstances, like a need for money that can result in life-saving surgery for a loved one, this loan might be necessary. But short of those types of extreme events, taking a 401(k) loan may not be your best option.

The government has very strict rules about when you can use your 401(k) monies precisely because it wants you to have that money when you retire. It imposes fees, penalties and possibly taxes on most withdrawals. And if you leave or lose your job, you’ll have to pay the loan back on a very strict timetable or face further penalties.

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If Your DTI Is Over 50%, Consider A Debt Relief Plan

At the far end of the debt spectrum, where debtors are being hounded by creditors, there are remedies to consider that can help you manage your problems, albeit at the price of severe damage to your credit score.

Before agreeing to any debt relief plan, you should think carefully and speak to a reputable credit counseling service, a financial advisor or an attorney specializing in debt relief and bankruptcy.

Negotiate A Debt Management Plan

Some of the more unscrupulous players in the debt relief industry masquerade as credit counseling services in order to pitch their debt management plan services. These services consist of contacting your lenders, renegotiating your balance and/or interest rates and then allowing you to make a consolidated monthly payment to the "credit counselor" – who then pays the lenders according to the new amount due.

Although many credit counseling services are available at no charge, debt management plans are not. In general, they cost between $50 – $100 to negotiate, and then $75 per month to service. If you’re thinking about getting credit help and the counselor immediately pitches a debt management plan, it’s a red flag that your best interests are likely not being considered. Walk away.

Settle Your Debt

A debt settlement plan is similar to a debt management plan in that both require a negotiation with creditors, but with a debt settlement, a creditor agrees to take a lump sum payment (usually far below the balance owed) as payment in full. Typically, creditors will only undertake these negotiations when they are convinced that you’ll end up with no choice other than bankruptcy, in which case they may get nothing.

Investigate Bankruptcy Proceedings

A bankruptcy is a legal proceeding that seeks to give debtors an opportunity to clear their past debts and get a fresh financial start. It also grants them immediate relief from their creditor’s collection attempts.

We must stress, though, that you should always reach out to your lenders first. Negotiating a deal is almost always a better option.

Let’s take a look at the two most common types of bankruptcy from the United States Courts: Chapter 7 and Chapter 13.

Chapter 7

If an individual is seeking to discharge their debts, makes below their state’s median income and owns few if any assets, they can file for Chapter 7 bankruptcy to discharge their debts.

Chapter 13

If you make more than your state’s median income or own significant assets, bankruptcy proceedings are a bit more complicated. The court will consider all of the individual’s debts and assets and decide whether the debts can be repaid with a court-imposed repayment schedule. The court will also consider the debtor’s assets and decide which to sell to repay creditors.

Final Thoughts: Debt Doesn’t Happen Overnight, And Neither Does Paying It Off

Becoming debt-free opens a lot of doors – you can finally free up cash to put toward your retirement savings, renovating your dream home or planning that European vacation you’ve always dreamed of (paid for in cash, of course).

Need help speeding up the process? Learn our tricks on how to get rid of debt fast.

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