What is the Best Way to Pay Off Debt?
Drowning in debt is stressful, but there’s hope if you're feeling overwhelmed and don’t have anywhere to turn. Sometimes all it takes are some simple tweaks to your habits and some debt payoff strategies.
Because each person’s financial situation is different, there isn’t necessarily one right way to pay off debt. Sure, your goal may be paying off all your debt within a year or so, but for some that is not feasible.
Here are some basic guidelines for getting started paying off your debt.
Understand How Much Debt You Have
Yes, this is a daunting step, but understanding exactly what you owe will help with your plan of attack. To start, gather statements from all the debts you owe.
Then, look at what you owe for each one and add it all up – you might even want to create a chart or a spreadsheet to help organize it all if you have multiple debts. You’ll also want to write down the interest rate you’re paying, what your monthly minimum payments are, and the length of your loan. This will be helpful, especially as you’re making tweaks to pay debt down faster.
Create a Budget
Now that you have your minimum payments down, work to fit these into your budget – are you already paying them? This is also the time to take an honest look at your spending habits. Is there anything you can cut back on? Do you have extra room in the budget to make more than the minimum payments?
Remember, cutting back is temporary, so if you feel like you’re seriously depriving yourself, keep in mind that this budget isn’t forever. And above all, it's a tool to help you understand your spending habits.
Modify Your Plan of Attack
In some cases, cutting back expenses might not be enough. In this case, consider finding ways to increase your income. Some suggestions include selling unused or unwanted items like books and electronics, starting a side hustle or negotiating for a raise at your current job.
As you get going, it’s helpful to review your debt payoff plan every so often to see how you’re progressing. You can also see if there’s any way you can modify your plans, such as paying your debt off more aggressively or finding other ways to save on interest (more on this below).
What Debt Should Be Paid Off First?
Ideally, you want to pay off the debts with the highest interest rates, since these will cost you the most throughout their duration. This is also known as the debt avalanche method. Some of these include credit cards, payday loans and private student loans (assuming they have a high interest rate).
Go back to your list of debts and see which fit into this category. If you can, try to make more than the minimum payments (while still meeting your obligations on your other ones) to pay them off fastest, then move onto another debt in the same manner until they’re all paid off.
Another popular method called the debt snowball suggests that you pay off your debts from the smallest to the largest balance. It’s similar to the debt avalanche method, except you make the minimum payments on the smallest loan first. Then, you do the same for another loan once that one is paid off, until you’re debt-free.
Both methods can help motivate you to continue you to pay off your debt. The avalanche method is best for those who like knowing they’re paying as little interest as possible, and the snowball method helps for those who feel motivated by seeing one loan after another paid off faster.
What’s the Fastest Way to Pay Off Debt?
One of the fastest ways to pay off debt is to pay more than the minimum payments on all your loans. That way, you can pay down the principal faster. Another perk is that you’re paying less interest. However, check your loan documents to make sure you won’t be hit with any prepayment penalties for doing so.
Making larger payments can be possible if you make more room in your budget by increasing your income. Also, consider putting any work bonuses or tax refunds toward debt repayment.
Another great way to pay debt down faster is to consider refinancing your loans. There are different types, so before pulling the trigger, look at the pros and cons of each one. A popular method is to use a personal loan. How this works is that you use the proceeds from that loan to pay off all your high-interest debts, so you’re left with one monthly payment that has a lower interest rate.
However, refinancing your loans is only useful if you can qualify for a lower interest rate. You’ll probably need a great credit score to do so. You may need to hold off until your score is higher, which means paying down things like credit card debt for the time being.
Less credit card debt can mean a better credit utilization, which means a better credit score, which means you can get a better interest rate, which means you pay less interest on loans. So if you’re looking to consolidate your debt, monitor your credit score – RocketHQSM does this for free – and find out as soon as possible if you qualify for better rates.
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What is Debt Consolidation (And Does it Make Sense for You)?
Debt consolidation is a strategy you can use to combine multiple debts into one easy-to-manage payment. Read our article on what it means to consolidate debt.