How to Pay Off Debt
Debt. The bane of our existence. Imagine the things you could do if you were debt free. I have a long list. But do you know how to pay off debt?
Unfortunately debt is a necessary part of life for those of us who aren’t fortunate enough to blessed with more money than we know what to do with. But that doesn’t mean that you have to spend your life under a mountain of debt, destined to drown in it and pass it on to your loved ones.
Learn these easy methods to pay off your debt fast.
Use your budget to pay off debt
The first step to paying down your debt as soon as possible is to start with a budget. We’re not going to get into the in’s and out’s of budgeting right now, but if you follow the 50/30/20 method like I do, 20% of your income should be put towards paying down your loans/lines of credit or saving money.
If you’re really enthusiastic about paying off your debt early, you can dip into the 30% set aside for wants and move it over to the debt/savings section.
Most importantly, a good budget is an honest budget. Being honest with ourselves when it comes to money can be very difficult. It’s easy to push aside the things we don’t want to think about, including debt that’s piling up. Make sure to include all your sources of income and every single one of your debts. We want to look at credit cards, car loans, student loans, mortgages, home equity loans, personal loans, medical debt and anything else you can think of.
Only then can we really make progress.
Methods to Pay Off Debt
There are a couple different methods that people swear by to help you pay off your debt faster. And even better, they’re super simple to keep track of.
Highest Interest Rate Method
As the name implies, we start by listing out all your current debt. Included in this list should be the interest rates for each item. Then we sort the debt by interest rate from highest to lowest.
The idea here is to put your hard-earned dollars toward paying off the debt with the highest interest rate. After paying off the debt with the highest interest, start paying extra on the next highest.
By paying off your debt based on the interest rate, you’ll save more money. The less interest you’re stuck paying, the more money you’ll have in the long run. Mathematically this is your best option for saving money.
The Snowball Method starts out just like our previous method. We want to come up with a list of our debts and sort them. This time rather than sorting by interest rate, sort them by the total balance owed. This is the order we’ll pay them off.
But the Snowball Method doesn’t focus on math. We don’t care about the math right now. The hardest part of personal finance is changing behavior. We know in our mind that the debt needs to be paid off, but actively paying it off is much harder. Just making the minimum payment and putting our money we have right now towards something fun is waaayyyy easier.
The idea behind the Snowball Method is to roll the snowball down the hill, gaining momentum and growing the further down the hill we get.
Pay off Debt #1
We start by putting some extra money towards the smallest balance that we owe. Maybe it’s a credit card with a low limit like $300. Instead of making the usual $35 minimum payment, we put a little extra towards the card.
In this example, we get paid weekly. Every week we take $75 from our paycheck that we would typically use to go out to eat, and use it to make an additional payment on the credit card. After just 4 weeks of $75 payments, the credit card is paid off.
We’re feeling good. There’s no better feeling than crossing something off on a to-do list, right? So now we use this momentum and start on the next smallest debt on our list. Let’s cross it off.
Pay off Debt #2
Maybe the next item on our list is an unsecured personal loan from the bank and we still owe $1,000. But again we were only paying the minimum payment every month, $50.
The beauty of the Snowball Method is that, with each item we pay off, the more money we’re going to have to put towards the next debt. Not only are we going to keep setting aside $75 a week from every paycheck to put towards our debt, but now we also have an extra $35 in our budget that we used to put towards the credit card we just paid off. So we add that $35 to our regular monthly payment on the personal loan, making that $85 a month.
So now after making payments of $85 per month, on top of $75 each week, we can pay that $1,000 loan off in 10 weeks. If we just kept on making the regular $50 a month on this loan, it would’ve taken us close to 2 years to pay it off.
See the difference this makes?
And from there, we keep snowballing into the next smallest payment, now with an extra $85 to put towards the monthly payment, and $75 every week.
Before you know it, the debt is gone.
This method of debt reduction is easy! The momentum we gain from paying off each debt early motivates us to pay off the next one, and the next one, until there’s nothing left to pay off.
Play it Smart and Stick With It
The key to making any debt reduction strategy work is to stick with it. The larger the debt we have, the more time it’s going to take to pay off. But think of the satisfaction you’ll have knowing that some small, simple actions you took led you to a (relatively) debt-free life.
Once you reach the point that you have a few things paid off, don’t stall your momentum by maxing out that credit card again on another big purchase, otherwise you’re back to square 1.
It’s time to take control of your money.
Do you have another method you used to pay off your debt? Let us know in the comments.