Especially in this economy, one place you don’t want to find yourself in is debt. Life is expensive enough without hemorrhaging money in interest charges.
Still, it’s a situation that’s becoming increasingly common. If you’re one of the many looking for an escape from the heavy burden of debt, give these proven strategies a try.
The first step to getting out of debt
To be sure, there are powerful strategies to eliminate debt. But for any of them to work, it’s critical to identify and fix the circumstances that caused that debt in the first place. You may be struggling because of a job loss, a large emergency purchase, or simply impulse purchases. Whatever the case, you won’t be able to zero out your debt with the following methods unless you address those issues. You’ll also need to know:
- How much debt you have.
- Your total monthly spending on necessities like rent, utilities, food, gas, etc., as well as your minimum debt payments.
- The amount of remaining income that can be channeled toward paying down your debt faster than just the minimums would accomplish.
This will give you the information you need to budget properly and help you decide which strategy will best serve your needs.
Debt snowball method
The debt snowball method to getting out of debt is a simple concept: Pay off your balances in order of size, starting with the smallest and working up to the largest. This is the fastest way to eliminate the number of outstanding accounts you have, thereby lowering the number of monthly fees you’re paying toward.
As you eliminate your balances, you’ll free up more of your monthly income to put toward your remaining debt (effectively “snowballing” the amount of funds you can use to pay down your loans). Plus, you get the mental win of seeing accounts zeroed out sooner.
For example, you may have the following estimated credit card balances and payments:
- $2,000 ($70 monthly minimum payment)
- $4,000 ($110 monthly minimum payment)
- $5,000 ($150 monthly minimum payment)
With the snowball method, you would pay off the $2,000 balance first. This would give you $70 more per month to throw at your next target, the $4,000 balance.
Debt avalanche method
The debt avalanche method favors targeting accounts with the highest APR (annual percentage rate) instead of the lowest balance. The idea is to knock out the cards that are costing you the most in interest. As an example, let’s say those aforementioned hypothetical credit card balances are subject to the following APRs:
- $2,000 (22% APR)
- $4,000 (19% APR)
- $5,000 (27% APR)
The avalanche method dictates that you focus on the $5,000 balance first, followed by the $2,000 balance. You won’t lower your number of outstanding balances as quickly, but you may save money on interest charges in the long run.
Debt consolidation
One of the biggest factors of your credit score is credit utilization. This is calculated based on the percentage of revolving credit that you’re currently using. For example, if you’ve got a total credit limit of $50,000 and you’re currently using $25,000 of it, your credit utilization is 50%.
Experts recommend keeping your credit utilization below 30% to avoid negative impact on your credit score. If you’ve got considerable debt, your credit utilization may be well above that—which can result in an unimpressive credit score.
However, if you’ve still got a good credit score (ideally 670+), you may opt for one of the below methods.
Debt consolidation loan
With a debt consolidation loan, you’ll receive a chunk of cash to repay multiple credit card and/or loan balances. This wipes out your current collection of monthly payments and replaces them with a single installment loan payment. Depending on the term length you choose, the new loan’s minimum payment may be a big one—but it can still be considerably less than the combined total of the many monthly payments you’re currently making.
And because debt consolidation loans are installment loans, the money you use to pay off your credit card will almost immediately improve your credit utilization. You may see a huge credit score increase in just a month or two.
Balance transfer credit card
You can also consolidate your debts by opening a balance transfer credit card and relocating your current debt onto it. Several credit cards come with 0% intro APR for a year or two. That can quite easily save you hundreds (even thousands) of dollars per year, depending on your amount of debt.
There are two caveats to this strategy:
- You’ll often have to pay a balance transfer fee (typically up to 5% of the transfer amount).
- You can only transfer as much as your balance transfer card’s credit limit can hold—including the balance transfer fee. For example, if you receive a credit limit of $15,000 and a balance transfer fee of 3%, you’ll only be able to move a maximum of $14,563 ($14,563 + 3% = $14,999).
Also, balance transfer credit cards typically require that applicants have good to excellent credit to qualify.
Increase your income with side hustles
One word of caution: While making more money is always the ideal, a plan to increase your income will ideally complement your current budget. For example, the goal isn’t to make more money so you can be more cavalier with your budgeting; rather, it’s to channel more money toward your balances.
From freelancing to reselling to rideshare to delivery platforms, there are numerous ways one may be able to make extra money. Often it takes just a few minutes to register with an app to launch a side hustle.
Negotiate directly with your creditors
Did you know that you might receive more favorable repayment terms simply by calling your lender and asking? You may receive a lower interest rate, a reduced monthly payment, even a temporary payment pause.
This doesn’t mean that banks are philanthropists—they want the money you owe them. If they think the most likely path to repayment is to give you a bit of a break, they’ve been known to do it.
Negotiating with your creditors doesn’t hurt your credit score. However, the bank may treat you differently after the call. Now that the lender knows you’re struggling, you may find your credit limits lowered (which can indirectly affect your credit score). The bank may also make a note on your credit report that they’ve given you some sort of hardship plan. This can be a red flag to other would-be lenders.
Get professional help
If you can see a way out of your current debt, there are professional services of varying degrees of severity to choose from.
Nonprofit credit counseling and debt management plans
With credit counseling, an experienced counselor will examine your situation and advise you of your best course of action. If necessary, they may suggest that you enroll in a debt management plan (DMP). This rolls your unsecured debts into a single payment, typically with reduced interest rates.
The act of enrolling in a DMP won’t itself hurt your credit score. However, you’re often required to close the credit cards you’re using the DMP to consolidate. This can negatively affect elements of your credit score, such as your average length of credit history and credit mix. Your credit utilization may also increase, as your total available credit will drop.
All to say, your credit score may drop temporarily—but it’s a small price to pay for getting your finances back on track.
Debt settlement
Debt settlement is more serious than a DMP. Instead of simply consolidating your debts into one feasible monthly payment, debt settlement involves negotiating with your creditors to pay back less than you owe. Debt settlement companies typically ask that you stop paying on your loans—effectively strongarming banks to the negotiating table.
This strategy wrecks your credit score. You’ll also likely receive aggressive collections calls and even lawsuits before you’re able to settle. Avoid this route if possible.
Bankruptcy
The last resort for those who can’t pay back their debts is bankruptcy. This can erase much of your unsecured debt, such as credit cards, some personal loans, and medical bills. It won’t make everything disappear, however (think tax debts, many student loans, child support, etc.)
Bankruptcy will blemish your credit report for up to 10 years. It can also drop your credit score by hundreds of points. You could even lose assets, such as personal property and home equity, to pay your creditors.
The takeaway
There are many tactics to getting out of debt, from the well-known “snowball” and “avalanche” methods to debt consolidation to debt management plans. No matter your specific financial situation, there’s likely a solution for you. None of them are easy (staying out of debt takes discipline enough, let alone digging yourself out of a hole), but with smart decision-making and stick-to-it-iveness, these strategies can help you make real progress.
Frequently asked questions
Where should I start if I feel completely overwhelmed by my debt?
If you feel completely overwhelmed by your debt, the first place to start is auditing your current monthly spending. This will help you to understand which areas of your spending you can redirect toward your balances. Once you’ve got that figured out, you can decide which strategy best works for your situation.
Should I focus on paying off high-interest debt first or smallest balances first?
Both of these methods have proven to be an effective way to pay off debt. If your multiple balances have similar interest rates, pay the small balances first. If you’ve got an account with an astronomical interest rate, focus on that first.
Do balance transfer credit cards really help you get out of debt faster?
Balance transfers can in many situations help you get out of debt faster. You can combine multiple debts into one, potentially lowering your monthly minimum payment. Many balance transfer cards also offer 0% intro APR—meaning every dollar you pay on your debt will go toward the principal during the interest-free period. It’s important to stick to a repayment schedule so you zero out the card’s balance before the intro APR period ends.
When should I consider a personal loan to consolidate high-interest debt?
You should consider a personal loan to consolidate high-interest debt if you’re able to obtain either a notably lower minimum monthly payment or a considerably lower interest rate than the one(s) you’re currently paying.
What’s the difference between debt consolidation, debt management, and debt settlement?
Debt consolidation is the act of rolling multiple debts into one. Debt management is working with a credit counseling agency on a structured repayment plan, typically with a single monthly payment and a lower interest rate. Debt settlement is negotiating with your creditors to repay less than you owe—often after your accounts have become delinquent.
In today’s challenging economic climate, falling into debt is a common concern that can lead to significant financial stress. To effectively manage and eliminate debt, it’s essential to first understand the underlying causes of debt accumulation, whether due to job loss, unexpected expenses, or impulsive spending. This understanding can pave the way for implementing effective strategies to regain control over finances.
Assessing Your Debt Situation
Before diving into debt repayment strategies, it’s crucial to evaluate your financial situation. You need to know:
- Total Debt Amount: Calculate how much you owe across all debts.
- Monthly Necessities: Identify your monthly essential expenses, including rent, utilities, food, and minimum debt payments.
- Remaining Income: Determine how much income is left after covering necessities and minimum debt payments. This amount can be allocated to pay down debt more aggressively.
With this information, you can create a clear budget and choose the most appropriate debt repayment strategy.
Debt Repayment Strategies
Debt Snowball Method
The debt snowball method focuses on paying off debts from the smallest to the largest balance. The logic behind this approach is that eliminating smaller debts first provides psychological motivation through quick wins, allowing you to apply freed-up funds to larger debts. For instance, if you have three credit card debts of $2,000, $4,000, and $5,000, you would pay off the $2,000 debt first. Once cleared, you can redirect that payment towards the next debt, effectively increasing your repayment amount as you eliminate each account.
Debt Avalanche Method
In contrast, the debt avalanche method prioritizes paying off debts with the highest interest rates first. This strategy can save you money on interest over time, even if it doesn’t reduce the number of debts as quickly as the snowball method. For example, if your debts carry APRs of 22%, 19%, and 27%, you would focus on the 27% balance first, potentially saving on overall interest costs.
Debt Consolidation Options
Debt Consolidation Loan
This approach involves taking out a loan to pay off multiple existing debts, consolidating them into a single monthly payment. This can simplify your finances and potentially lower your interest rate, making it easier to manage your debt. However, it’s essential to ensure that the new loan’s terms are favorable compared to your existing debts.
Balance Transfer Credit Card
Another method of consolidation is transferring your debts to a balance transfer credit card, which may offer a 0% introductory APR for a certain period. This allows you to pay down the principal without accruing additional interest. However, be mindful of balance transfer fees and the credit limit restrictions that may affect how much debt you can move.
Increasing Your Income
Consider finding side hustles to generate additional income, which can provide extra funds to pay down your debts. Options include freelancing, reselling items, or participating in rideshare or delivery services. This additional income can be a crucial component of your overall debt repayment strategy.
Negotiating With Creditors
Many people are unaware that they can negotiate directly with their creditors for better repayment terms. By communicating your situation, you may secure lower interest rates or reduced payments. While this won’t harm your credit score, it may lead to lower credit limits or notes on your credit report indicating you’re in a hardship plan.
Seeking Professional Help
If self-directed efforts seem overwhelming, professional assistance is available:
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Credit Counseling and Debt Management Plans (DMPs): Nonprofit credit counselors can help you assess your financial situation and may recommend a DMP, which consolidates your unsecured debts into one monthly payment, often with reduced interest rates.
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Debt Settlement: This more aggressive strategy involves negotiating with creditors to settle debts for less than what you owe, usually after missing payments. However, this can severely impact your credit score and lead to aggressive collection calls.
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Bankruptcy: As a last resort, bankruptcy can eliminate many unsecured debts but will have long-term negative effects on your credit history. It can also result in the loss of assets, so it should be considered only when all other options are exhausted.
Conclusion
There are various methods to approach debt repayment, including the debt snowball and avalanche methods, consolidation, and professional assistance. Each strategy has its pros and cons, and the best choice depends on your individual financial situation. While getting out of debt requires commitment and discipline, the right approach can lead to significant progress and financial stability. By addressing the root causes of your debt and implementing a tailored repayment strategy, you can regain control over your finances and work toward a debt-free future.
