Debt doesn’t have to be a burden. You can begin to pay off debt immediately if you change your money mindset and behaviors. Change is often difficult for many people. We’ve always done things that way, is a typical response when change is introduced. One good way to overcome this when thinking of how to pay off debt is to define a reason why you want to make the change.
If you have debt, I bet you think about how to pay off debt quite often. In fact, that debt might be the primary source of stress in your life. Debt can make you anxious, keep you up at night and cause problems in relationships. According to an AICPA survey:
- More than half of Americans with debt say it has negatively impacted their lives
- Millennials are twice as likely to worry about their debt compared to Baby Boomers
- Household debt is now at a record high
A “Why” is just like a goal or resolution, but may be more personal than your typical board resolutions like I want to lose weight, or eat healthier. A money “why” or purpose may sound something like I want to provide better for my family. I want to reduce money stress in my life. My family and I would like to buy a house. I want to be on the same page with my spouse when it comes to our money.
There’s no one size fits all solution to paying off debt, so having a personal why will help keep you motivated to reach the end goal. So how do you pay off debt? Here are some of the best tips and resources to be successful this year.
DON’T FOLLOW THE HERD
Herd mentality describes how people can be influenced by their peers to adopt certain behaviors on a mostly emotional, rather than rational, basis. The herd mentality is one you need to break ASAP to be successful in paying off debt.
Just because everyone else has debt doesn’t mean you have too. Your parents, friends, and co-workers way of doing things doesn’t have to be yours. You need to think and act for yourself and not just follow someone else script.
Just because your parents owned a home and a jumbo mortgage, doesn’t mean you need to take one on too. A friend taking on student loans to finance college and living expenses doesn’t have to be your blueprint. A co-work just spent $40K on a new car because he got a raise doesn’t have to be your reality.
Defining your path, and what’s right and wrong for your family should be decided on by what’s best for you, and not just getting in line behind the crowd.
GET HELP / EDUCATE YOURSELF
Any time you are trying to master a new subject or skill, increasing your knowledge on the topic is a must, including when you are working to pay off debt.
There are many resources you can tap to increase your financial IQ.
- Blogs – You can read a personal blog like Debt Discipline or use a mainstream site like Investopedia
- Books – There are many books on personal finance. Two great ones to start with are The Total Money Makeover and The Millionaire Next Door.
- Podcast – There are plenty of podcasts too if audio is your preferred medium.It’s great to listen while commuting or doing work around the home. Planet Money and Freakonomics Radio are two good choices to start with.
If any of the above resources don’t get you excited and you need a more personal approved, find someone you can help you. You might enlist a friend who is successful with their money to help you understand how they have done so. You could hire a coach or planner to help dig into your numbers and act as an accountability partner as you pay off debt.
FIGURE OUT HOW MUCH DEBT YOU OWE
A core step in paying off debt is to know your debt numbers. Grab all of your statements and begin to write down each debt type. Debt comes in all shapes and sizes so be sure to include mortgages, student loans, and credit card payments.
Be sure to include the total amount due for each debt, including interest rate, minimum payment, and due date.
Taking this exercise a step further to include all spending in your notes like utilities, personal care, subscription services, etc., as well as all sources of income. Collecting all of your income and expenses for a month time frame will give you an excellent basis for a budget. Check out my resource for a budget here.
But let’s get back to the amount due, including interest rate, minimum payment, and due dates.
Total all of your amount dues, to give you your entire debt number. Understanding your interest rate gives you an idea of which debts will cost you more over time. The minimum payment gives you the bare minimum you need to include in your budget each month. Finally, the due date helps you manage your calendar for repayment.
Getting to know your debt and an overall financial picture will help you prepare to pay off debt fast, which I’ll review in the next few steps.
Another great way to understand how your money is being spent is to track all expenses for one to three months. This exercise will help identify any money leaks or habit spending that you may be doing and not even realize it.
Finally, once you have all of the information jotted down, it best to transfer to a spreadsheet or app like personal capital to help keep track of your progress.
STOP ACCUMULATING NEW DEBT
The best time to pay off debt is today. Well, actually it would be yesterday, but here we are. To avoid increasing your debt total you need to stop accumulating new debt immediately.
To reverse the trend, you need to avoid new debt. With the steps outlined above, you have the information to begin to make that happen.
A weapon in doing this is some type of cash saving, often called an emergency fund.
Have a cash saving as little as a $1000 will avoid you from taking on new debt when the unexpected happens.
Ever have car trouble? An appliance break in your home? I think we can agree life happens, so be prepared for it. The amount of cash reserve is really up to you, but you don’t want to have too much saved during debt repayment that it delays your ability to get of debt.
USE THESE PAY OFF DEBT TOOLS
Now that you have our debt numbers, you’ve prepared for the change, increased your knowledge on the topic, and have a motivating reason to move forward, let’s dig into the tools to pay off debt.
When you are trying to pay off debt, let your creditors know. Some will be willing to work with you. You can call credit card companies and ask for a reduced interest rate. If you have a lump sum bill like a medical bill, you can call and try to work out a realistic payment plan. Even better if you have the available cash you can ask for a reduced amount if you pay it in full.
Creditors want to know they will be paid, certainly, if you are delinquent on the account so opening a line of communication with them may not be a bad thing.Make sure you get names when you call and always ask for confirmation to be sent in writing of any rate reductions. This way you have a record of it.
The worst you can receive is a “no,,” and you can call back at another time and speak with someone else or escalate to a supervisor or manager.
PAY OFF DEBT CALCULATORS
Many financial apps and calculators are available free on the world wide web. These tools are great to use to help calculate how long it will take you to pay off debt.
The also to give you the ability to play “what if” scenarios easily. What if you had a lower interest rate, or what if you had more money to apply to your debt payment.
Using a pay off debt calculator may help inspire you to make even more changes to your repayment plan.
Another great suggestion is to tap into your current bank or credit union for resources. Today many offer free financial education, credit counseling, and tools that assist you in debt pay off.
Two of the most popular debt pay off method are the debt snowball and the debt avalanche. Here’s an outline on both.
The debt snowball is an accelerated debt payoff strategy. It’s called the snowball because like a small snowball or anything for that rolling downhill it begins to pick up momentum.
Here are the nuts and bolts of the debt snowball in five steps:
- List all debts smallest to largest. (This information should already be captured in the above: Figure out how much debt you owe)
- Make minimum payments on each of your debts every month.
- Target your smallest debt, and apply as much money as you can above the minimum payment each month.
Once the smallest debt from step three has been paid in full, roll its complete payment to your next smallest debt.
- Repeat step four until you are debt free.
The fact that you are targetting your smallest debt first helps build the momentum in your debt repayment plan. Just like that snowball rolling downhill. Having a win each time you pay off debt helps sustain momentum.
The debt avalanche is another accelerated debt payoff strategy. It’s called the avalanche because it’s likelier to pay off debts in a shorter time and save you the most money on interest.
Here are the nuts and bolts of the debt avalanche in five steps:
- List all debts largest interest rate to the smallest. (This information should already be captured in the above: Figure out how much debt you owe)
- Make minimum payments on each of your debts every month.
- Target your largest interest debt, and apply as much money as you can above the minimum payment each month.
- Once the largest interest debt from step three has been paid in full, roll its complete payment to your next largest interest debt.
- Repeat step four until you are debt free.
To best understand which if the snowball or avalanche payoff method might be right for you, leverage the pay off debt calculator mentioned above to test out some “what if” scenarios to conclude what works best for you.
ADDITIONAL STRATEGIES FOR PAYING OFF DEBT
If you are still looking for some tips on how to pay off debt. Here are five different suggestions that may help you reduce your debt.
A balance transfer is a process of transferring high-interest debt from one credit card to another card with a lower interest rate. This process will help apply more of your payments to the principal balance each month rather than interest charges.
This process can help you eliminate your card debt faster. The key is not to use the new account or credit limit to add more debt.
How do you determine if a balance transfer is right for you?
Find a new credit card with a very low-interest-rate, little or no balance transfer fee and a credit limit high enough to accommodate your previous balance. Also, make sure you have an introductory period long enough to pay off the balance before the rate increases.
If you can meet all of the above criteria, then a balance transfer is a good idea.Untimely a decision like this has to work for your personal situation.
When you consolidate, you need to have multiple debts. One of the reasons to consolidate is to simplify your overall payments. A debt consolidation loan typically combines several unsecured debts into a single new loan at a lower interest rate.This process helps organize payments into a single loan.
The key to using this is that you change your behavior and don’t accumulate any new debt, only focus on paying off the debt. This is where many people fail, the use consolidation loans to get organized, but continue to overspend and rack up more debt outside their new loan, causing an even bigger problem.
Refinancing is the process of replacing an existing loan with a new loan. You would typically, refinance a loan to reduce monthly payments, lower interest rate, or change their loan program from an adjustable rate to a fixed-rate.
Generally refinancing is associated with a mortgage loan, but car loans and student loans can be refinanced too. The key to understand when refinancing is usually the process restarts the amortization process. So it best to do your homework and understand the benefits are refinance before you do so. Will the new loan cost you less than your current.
A loan refinancing calculator is an excellent place to start.
You have probably heard debt settlement advertised on radio and television. Debt Settlement is when the debtor and creditor agree on a reduced balance that will be regarded as payment in full — the debt settlement company act as the middle man.
During a negotiation period, you stop paying your creditors and pay the debt settlement company instead. They will build up your monthly payments in an account. Once all the debtor’s accounts are in default due to this non-payment, the debt settlement company has the leverage and will contact your creditors on your behalf and try to negotiate a settlement.
If they are successful, they will charge you a percentage of the overall settlement, sometimes upwards of 10-15%. Keep in mind that your credit rating goes down significantly due to the default. Even though the accounts are “settled,” the default appears on the debtor’s credit record for several years.
DEBT MANAGEMENT PROGRAM (DMP)
What’s a DMP? A debt management program is when a debt management company works directly with your creditor to reduce your interest rates so that more of your monthly payment is going towards the principal and less towards interest. This process allows you to pay the debt back sooner.
You make your monthly payment directly to the DMP Company and they, in turn, pay the creditor. The DMP Company typically charges a fee for their service.
Many banks or credit union offer credit counseling as a service and not charged a fee if you are a member.
Creditors often like working with DMP companies because it almost guarantees repayment, and they are more willing to reduce interest rates because of this fact.This process usually will not result in a credit score drop.
In theory interest rates can go from 18-20% to 1.5-2.5%. All accounts will need to be closed. If you are unsuccessful with negotiating lower interest rates on your own as suggested above calling a DMP company is recommended. Many offer a no-obligation discovery call to see if they would be a good fit for you.
ELIMINATING DEBT TO MAKE YOUR INVESTMENTS REALLY PAY OFF
There is a classic question in personal finance circles about debt and investments:Should I invest if I have debt? There are different ways to answer the question, but the most common response urges individuals to invest only when return rates exceed the interest rate of personal debts. Here’s an example.
Let’s say you have student loans at 7% annual interest. You also have a Roth IRA filled with index funds that bring in 9%. Because your IRA is generating returns 2% faster than your debt is taking your money, you can comfortably invest away as long as you maintain your payments.
On the other hand, people tend to recommend that investments not be pursued until higher interest debt (like credit cards) is eliminated. This is because these debts accumulate at rates in the 12-30% APR zone. It is tough to find an investment that grows faster than that, so even if you’re making impressive returns, you’re probably losing money faster than you’re gaining.
If you have debt, especially high-interest debt, you should start looking at debt consolidation companies if you are serious about significant investment returns in your future. Debt consolidation can create a single debt target with a single interest rate, rather than many debts held with various companies. If you can put every spare dollar into these debts, you can kill them off faster, then open up your income for investments in the future. The key when consolidating debt, it to address the underlying behavior that got you into debt in the first place. If you don’t address your overspending behavior a debt consolidation loan will not help you, it will only exacerbate your situation.
THE POWER OF COMPOUND INTEREST
However, this is not the only way to do things. Even if you have high-interest debt, there is an argument for investments even before you’ve eliminated it. This advice is conditional. Unless you have sufficient resources to lower your debt while still making investments allocation significantly, you’re not going to end up in a good place.
This option is available because of the power of compounding. Invested money grows (at least most of the time). The more money you have, the faster it will grow.This is because when dividends and other returns are reinvested into your principal investment balance(s), they create a snowball effect.
Let’s say you have $100,000 in a tax-free Roth IRA. You make 10% returns the first year, giving you $110,000 the next year. If you make another 10% the following year, you’ll have 121,000 at year’s end. When you get into seven digits of investment money or more, you can earn hundreds of thousands of dollars each year, without doing any work at all. But this takes money. If you wait to invest until your debt is completely gone, you won’t have a lot of time for your investments to grow through compounding.
That’s why, if at all possible, max out your IRA and other retirement accounts each year, no matter what else you do. Of course, you’ll have to pay off your debt aggressively at the same time. If you are not able to do both, choose debt reduction.But if you can pull it off, work on both and watch your investments snowball accumulate even as you beat down your debt.
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