Do you need to pay off debt?
The median household debt in America is around $59,000, this includes credit cards, car payments, student loans, and mortgages. If you have debt that is holding you back in life, you definitely are not alone. If you are sick of living to pay other people and tired of feeling that you have no control over your money, you can dig yourself out of debt! So long you are ready to put in the work, you can totally pay off your debt.
Are you ready to change your spending habits to prevent unnecessary expenses and maybe even get a temporary side job for a little while in order to achieve zero debt as fast as possible? If so, you can tackle your debt and begin your journey to financial freedom. Here’s how:
1. Pay off Debt- Know How Much You Owe
Before you can start making a big push to pay off debts, you first have to know what you owe.
Go through every bill and statement to make a list of every single outstanding balance you have
- Credit cards (big, small, store credits, everything)
- Past Due Utilities (Phone, electric, water, etc)
- Loans (personal loans, home improvement loans, car loans, etc)
- Doctor or medical bills (Hacks to Reduce Medical Bills)
- Student Loans (private and government-sponsored)
- Mortgage Loans
Make a list of every outstanding balance you have and write down:
- Name
- Balance
- Interest Rate
- Minimum Payment
Once you know where you stand, you can begin forming a strategy for how to get rid of it. How do you eat an elephant? One bite at a time!
2. Pay off Debt- Ensure You Have an Emergency Fund
The main reason people go into debt, and stay there, is because of everyday “emergencies”; maybe your car tire blows out, your kid breaks their arm at school, or you get laid off from work. Every time you feel like you’re making progress paying off your debts, something happens and you have to put it on a credit card, pushing you further back. So before you begin your great debt reduction journey, make sure you build a decent emergency fund.
A lot of people say you should have 3-6 months’ worth of living expenses in your emergency fund, this is great, sometimes it should even be more, but for a lot of people, it could take up to a year or more to save that much, all the while, your debt continues to grow.
Take a look at your situation:
- Is your job secure or would it be super easy to find a similar-paying job in a short amount of time?
- Do both you and your spouse work and could cover basic living expenses if one of you lost your job?
- Maybe a close relative would be able to step in and help by letting you move in with them or help cover some of your basic costs.
If you are in a steady situation, you may not necessarily need 3-6 months of living expenses in your emergency fund to start your debt payoff. Maybe a month or 2 to get you started is sufficient. But if you have inconsistent income, a high probability of losing your job or having a hard time finding a similar paying one, you might want to aim for the 3-6 months of living expenses. But do what feels comfortable for you.
Plan For Potential Emergencies
When trying to decide the right amount of emergency funds for you, look around your life and see if you have any potential upcoming “emergencies.”
- Is your car due for an oil change or fluid flush soon?
- Do you have a thin spot on your roof that may need replacing in the next year?
- Is your hot water heater 10 years old and due to die at any time?
- Are your tires balding?
- Does your kid have a big field trip or sports registration coming up?
Plan for and save for these expected expenses ahead of time so that you can pay cash for them when the time comes as they have already been budgeted for. This will help you to prevent additional debt from entering your life due to “emergencies”.
Figure out what size emergency fund you need and save it up as quickly as possible while just paying the minimum payment on your debts. Also realize that as life happens, you will have to pull out of your emergency fund every once in a while and may have to slow your debt payments for a short while as you rebuild your emergency fund. After a while, you will get used to saving for “everyday emergencies” and paying cash. They will soon feel less like emergencies and more like everyday expenses.
3. Pay off Debt- Get Your Employer Match
Another important step before beginning your debt payoff is to ensure you are getting any employer matches in your work retirement fund. If your job offers a 3% match, not getting that match is like telling your boss “no thanks, I don’t want that 3% raise.” Just set it up with your Human Resources department to ensure you are putting the minimum amount required into your retirement fund to get the match.
3% from your check, pre-tax, will feel like hardly anything from your paycheck but paired with your employer’s match, it can slowly begin to amount to big money. At a 7% interest rate (which is very reasonable in a simple target date fund), your money will double every 10 years. So take advantage of that employer match and let your money grow for retirement even while paying off debt.
4. Pay off Debt- Decide on Avalanche vs Snowball Pay Down Method
Ok, so you know what you owe, you have a decent emergency fund so that you won’t have to take on more debt when life’s little “emergencies” pop up, and you’re putting at least the minimum amount of money into your retirement fund to get your employer match, now comes the fun part: Paying off that debt and buying back your freedom!
Avalanche Method vs Snowball Method?
Avalanche Method
With the Debt Avalanche Method, you line up all your debts in order of highest interest rate to lowest interest rate and start paying from the top. This is technically the most efficient method, by paying off the highest interest rate loans first, you are saving the most money on interest. You will continue to pay only the minimum amount on all other debts while throwing every dollar possible at your highest interest balance.
Once the highest interest account is paid off, you do a happy dance and take all the money you were paying on that account and begin paying that, in addition to the minimum, on the next highest interest rate. Continue this process until all of your accounts have been paid off!
Snowball Method
The Avalanche Method can often be a slow process because your highest interest rate is not always the lowest balance causing some people to get discouraged at the seemingly slow rate of payoff. For those who need that mental check-off and happy dance more often to feel like they are really making progress, the snowball method may be a better option.
With the Debt Snowball Method, you line up all of your debt in order from smallest balance to highest balance. You then pay just the minimum balance on higher balances while you throw every available dollar at the lowest balance. When that balance is gone, do a happy dance and take all the money you were paying towards the previous lowest balance plus the current minimum and throw it at the next smallest balance. With this method, you will be zeroing out accounts faster and applying for larger and larger payments to the next account, like a snowball getting bigger and bigger.
5. Pay off Debt- Can You Refinance?
Often, people get themselves into credit card and loan situations when they are young or not in a place to shop around. If you have debt, like a car loan or student loan, that is high interest, see if you can shop around for lower rates.
I had a cousin that bought her first car in her early 20s. Because she had no credit history, the dealer gave her a loan with 19% interest! When she told us that the next week, we immediately took her to our credit union and helped her refinance the car for a much better rate, like 8%! That small effort of looking for a better deal saved her thousands of dollars.
If you have high-interest loans, shop around to see if you can refinance them for a lower interest rate. Just be careful and double-check any high closing fees (like on mortgages) that may throw off your potential savings.
6. When to Balance Investing with Debt Payoff
Once you’re on a roll paying off your debts, you may come to a point where you feel like all of your money is going toward debt and none toward your future. Even though you’ve got some money going into your retirement fund at work, you may feel like you could be getting a better return investing than paying off your debts, well, at a certain point, that may be true.
Paying off debt is the safest investment you could make for your future. Whatever interest rate your paid-off debt was is like earning the reverse investment returns. That 15% interest rate credit card you paid off just saved you 15% on that balance, that’s a pretty good return if you ask me.
As you pay off those higher-interest credit cards and loans, you will soon be left with, hopefully, low-interest but high-balance mortgages or government-sponsored student loans. These loans usually have interest rates in the 3-5% range and work on simple interest (interest only builds on the initial loan balance) vs those credit cards and private student loans work on compound interest (interest builds on the initial loan balance PLUS any previous interest added).
Start Investing
When you get to the point in which you only have low-interest (under 5%) loans, you can begin putting a portion of your debt snowball into your retirement funds, like more into your 401K or opening an IRA. Because the stock market usually returns at least 5% (after inflation) it makes perfect sense to balance out your debt payoff and retirement planning at this point.
But it is totally up to you and what you feel comfortable with. If paying off your home mortgage loan as early as possible is doable and gives you great relief, do it. Just make sure that as soon as your debt is gone, you take all of that snowball/avalanche and begin investing it for retirement so that you never have to worry about money again. Just do not go out and spend yourself back into a hole, you’ve worked too hard at this point.
Wrap Up
So if you are ready to tackle your debt:
- Figure out where you currently stand so you know what you’re up against. Remember, in order to eat an elephant, you take it a bite at a time.
- Ensure you have an emergency fund saved up so that you can prevent any additional debt from building.
- Make sure you are at least getting your employer match in your retirement fund so that even while you are paying off your debts, the power of long-term compound interest is working for you. At a 7% interest rate, your money will double every 10 years.
- Choose your debt pay-off strategy: avalanche or snowball. Continue adding payments from paid-off debts to the next balance to get it done faster.
- Once you achieve high-interest pay-off, begin slowing your debt payoff to add to your retirement funds, getting you that much closer to financial freedom!
How to Tackle Paying Off Debt Check List
- 1. Know How Much You Owe
- List every outstanding balance you have by:
- Name
- Balance
- Interest Rate
- Minimum Balance
- 2. Ensure You Have an Emergency Fund
- 3-6 months or longer of living expenses if no back-up
- 1-2 months of living expenses plus “expected emergencies” if you have a secure back-up
- 3. Get Your Employer Match
- Sign up with HR to put away the minimum for employer match in a retirement fund
- 4. Decide on Pay-Off Strategy: Snowball vs Avalanche
- Avalanche- start at the highest interest rate and work down
- Snowball- start at the lowest balance and work up
- 5. Can You Refinance?
- 6. Balance Investing with Debt Payoff
- When all of your debt is below 5% interest rates, begin dividing your money between debt and investments in your future
Are you working on paying off debt? Do you prefer the Snowball or Avalanche method? Why?
Leave a comment below and join the conversation.
Make sure to share your favorite posts on social media and sign up for our weekly newsletter to get the latest posts delivered fresh to your inbox.
6 thoughts on “How to Pay Off Debt”