At Global Finance Matters, we promise to give you the best information we have about finance. One of the most important things you can do to improve your finances is to pay off debt. This post will take you through the best ways to make this a reality for you.
Before getting into this article, lets clarify the type of debt that we’re talking about paying off. When we talk about debt in this post, it refers to credit cards, student loans, personal loans, etc. Reducing auto and mortgage debts is a much longer process, however, the same principles can be applied.
Assess your debt situation
Before getting into the particular solution, you need to understand how serious the situation is. If you can divert your disposable income and pay off, your case is a little easier to manage. Greater than $10,000 of debt will require more planning and effort. For a deeper analysis of your financial situation, visit Learnvest here.
More detail regarding steps 1 and 2 can be found in our Bulletproof Budget post.
Step 1: Tracking Spending
When you are looking to reduce debt, you need to know what you are spending money on. People usually go into debt because they have been spending more than they earn. Find a way to keep track of where your money is going. A budget app is usually the easiest way to do this.
I have been using Mint.com for years and it has proven an effective tool for managing my spending. You can link all of your cash, investment and credit accounts and manage them through their app.
Step 2: Evaluate Your Spending
It is important analyze your spending because you can’t reduce spending everywhere. You can’t just decide this week to pay less rent or a smaller car payment. Separate your expenses into two categories. Expenses that can be reduced today and expenses that you cannot reduce easily.
Obviously, rent/mortgage, car payments, debt payments cannot be changed quickly. Even utility payments are difficult to reduce. It may be possible to go down to a basic cable package, but cancelling it may incur cancellation fees. This is still a good route to take, but you need to understand the consequences.
The spending that is left is on the chopping block. Here is where Mint.com can be an asset. You are able to set a budget for individual categories of expenses. The app will alert you when you get close to or beyond the budgeted amount.
Step 3: What is Your Net Income
You need to know exactly how much money you make on a monthly basis. Subtract your monthly spending from your income and that is your Net Income. Now that you know what your disposable income is, you know how much is available to pay down debt.
If that amount multiplied by 12 is enough to pay off your debt, then that is your plan. Take that amount each month and use it to pay your creditors and be debt free in a year.
This is much harder than it seems, which is why so many of us fall into this situation. To help you in your journey, make sure you have a partner in this process.
Involve your S.O. or family members or a close friend in this process so they will keep you on track. You have shown that you have trouble with spending so you need help staying motivated and on track.
If you have done the calculations and will not have enough to pay off your debt in one year, then move on to step 4.
Step 4: Prioritize Your Debt Payments
If you have amassed a large amount of credit card debt, don’t feel alone. As prices continue to inflate and incomes remain stagnate, it is more and more common. The first thing you need to do is to know the interest rates on all your credit accounts. You need to focus on any accounts that have rates above 20%. If these accounts are small enough that they can be paid off in a few months, then that should be your focus.
If the balances are large, we need to see if it is possible to reduce the interest rates. Credit card companies may be willing to reduce your interest rates if you call and ask. Yeah, it can be that simple.
Student loan debt should be the next item on the chopping block. Some experts will tell you to pay off student loan debt first because it cannot be eliminated in bankruptcy, but credit card debt can be. However, Credit Card debt typically has higher interest rates so it more costly.
You should continue making your student loan minimum payments until you pay off your credit card debt. You will also be able to structure the student loan payments to reduce them until you are able to pay more. Now that you can focus all of your debt maintenance costs to one loan, it will be paid off much sooner than anticipated.
Step 5: Start Paying
Next, place the accounts in order by balance in two groups, the high interest group and low interest group. You will start from the smallest accounts and focus on paying those down first. It is important to pay off the smaller accounts first because you will begin to see progress faster.
As the balances start to disappear, your confidence will grow and create positive momentum. With larger amounts of debt, the momentum is important to keep you inspired for this long process.
As the accounts are being paid off, divert those minimum payments to the next card in line.
Rinse and Repeat.
So to sum it up:
Track your spending
Evaluate your spending
Know your Net Income
Prioritize Your Debt Payments
Apologies for this post being lengthy, but it was important to go into the detail. Understanding what do to and why you are doing it will help you become more successful.
This post contains affiliate links and we will receive a commission for any sales.