If you feel like you’re drowning in debt, you’re not alone. Americans carry an average debt balance of $92,727. These debts come from a variety of sources like student loan debt, credit card debt, mortgage loans, and car loans. While many of these loans represent necessities, they add up quickly, making it difficult to keep up with monthly premiums. If your debt is spiraling out of control, it’s important to adopt a strategy to reduce your debt. However, finding the solution that works best for your unique situation and avoiding common traps requires careful planning. Here are a few ways to start paying off debt.
Common Strategies for Paying Off Debt With Hidden Costs
When you’re seeking strategies to pay off debt, many potential solutions offer hope. It’s important to avoid debt reduction strategies that might cost you even more money. These solutions solve one problem (usually high interest) but have sneaky disadvantages that could cost you more in the long run.
This is basically a loan that combines all your debts. Debt consolidation opportunities come from a variety of sources, which means you might be eligible even if you don’t have great credit. Consolidating your debts offers the chance for a single payment with one interest rate across the board. The downfall of this method is that payments will be stretched out over a long period of time and interest rates can increase without warning.
So-called debt settlement companies charge you a fee to negotiate with your creditors to reduce your debt. These offers typically claim that you can cut your debt by 50% or more. Debt settlement opportunities are often a scam that involves a fake or temporary company taking your money without providing any services. Legitimate debt settlement companies typically request that you stop paying your creditors and put your payments into an escrow account until a settlement agreement is reached. The act of halting payment will increase your debt with penalties and fees.
Borrowing from Your 401(k)
Dipping into your 401(k) could give you the opportunity to reduce your debt without taking out a loan. This might seem like a win/win, but withdrawing money early usually leads to fees, penalties, and additional taxes. Besides, you’ll need your retirement money when you retire.
Home Equity Loan of Credit (HELOC)
A HELOC allows you to borrow money against the amount of equity you have in your home. Using it to handle debt is risky. If you fail to pay back the loan on time, you risk losing your home.
Choosing a Debt Reduction Strategy for Your Situation
Going into debt is easy. Getting out from under it often feels impossible. Unfortunately, there are no magic fixes when it comes to reducing or eliminating debt. In order to reduce your debt and avoid falling into the same traps in the future, you have to change the way you handle money. Choosing a debt reduction strategy based on your specific type of debt can help you get things back under control. These strategies have been proven to help reduce or eliminate debt over time.
- Debt Snowball: Pay the minimum amount due on all of your payments except for the debt with the smallest total balance. By paying as much as you can toward the smallest balance, you can pay it off quickly and eliminate one payment. Then, you can put that money towards your second smallest loan to work your way up the chain.
- Debt Avalanche: This method focuses on debt with a high-interest rate. Instead of concentrating on the balance of each loan, put the bulk of your funds toward the loan that’s costing you the most interest.
- Personal Loan: If you simply can’t make your monthly payments on several debts, consolidation may be an option to get things under control. Getting a personal loan from a trusted financial institution can help you lower your monthly payments and possibly get a lower interest rate.
- Balance Transfer: Balance transfer cards work as a debt consolidation solution for high-interest credit card debt. Since these cards often offer a 0% APR for the first 12 months, you can transfer your debt from high-interest credit cards to the new card to save on interest.
Your Step-by-Step Guide to Paying Off Debt
A big part of getting out from under a mountain of debt is understanding exactly how much you owe. When you’re paying the minimum across several debts, it’s easy to avoid facing the reality of the total amount. No matter what reduction strategy you choose, there are certain steps you can take to help you reach success.
1. Assess the Total Amount You Owe
Debt is any amount that you owe to someone else. This includes bills like student loans, credit cards, medical debt, car loans, mortgage, personal loans, payday loans, and government or IRS debt. It doesn’t include your regular monthly bills like electricity, water, or groceries. Take a deep breath, list all your debt, and add up the numbers.
2. Examine the Details of Paying Off Debt
To choose the best reduction strategy for your debt, it’s important to know everything you can about your loans. For each of your debts, list the total balance, the monthly payment amount, the due date for each payment, and the interest rate.
3. Choose a Reduction or Repayment Plan
Using the details you’ve learned about your loans and your personal spending style, choose a plan to reduce your debt.
4. Create a Budget
Your commitment to reduce your debt will require you to change your spending habits. Create a budget the prioritizes your repayment plan but also provides a practical spending plan for your lifestyle. Your budget should include your monthly expenses, including your debts, utilities, transportation, insurance, and personal expenses.
5. Celebrate the Small Victories
Paying off debt is often a marathon instead of a sprint. Acknowledging your victories can help you stay on track. Plan a small celebration or treat to reward yourself for reaching each spending goal.
Top 5 Frequently Asked Questions About Paying Off Debt
Will paying off my debts lower my credit score?
Sometimes. Your outstanding accounts reflect your credit utilization, which is an important part of your overall score. When you pay off debts that close an account (like a car payment or a credit card that you close) your score may drop slightly. Revolving credit (like a card you keep open) will help you maintain your score as long as you make your payments online.
How often should I check my credit score?
If you don’t have any big financial plans, it’s fine to check on your credit score once a year to make sure you don’t see any accounts or inquiries you don’t recognize. If you’re planning on making a big purchase or qualifying for a mortgage, you should keep a closer eye on your score. Checking every few months will help you dispute anything that doesn’t belong and take actions to raise your score.
Should I sell my car to reduce debt?
There are certain situations when selling your car is a reasonable solution to reducing your debt. If the following situations apply, selling your car might be a good solution.
- You don’t need a car for your lifestyle
- You can buy a cheaper one and save on payments and insurance
- You have looming maintenance needs that will cost more than you’ll gain in the selling price if you repair it
Refinancing is another solution to consider if you’re underwater or simply need lower payments or interest rates.
Should I choose the snowball or avalanche method to pay off debt?
Choosing your method to reduce debt depends on your personality and your specific loans. The avalanche method concentrates on the interest rates while the snowball method utilizes the satisfaction of a reward. If you have debts with very high interest rates, the avalanche method will help you eliminate debt more quickly. If your interest rates are similar and you respond well to meeting short-term goals, the snowball method might provide more incentive.
Should I pay off my mortgage early?
If you have extra cash to pay extra on your mortgage, it’s always a good idea to lower your principal balance. However, you shouldn’t devote so much attention to your mortgage that the rest of your financial life suffers. For instance, you shouldn’t do any of these things to lower your mortgage.
- Spend your emergency fund
- Dip into your retirement savings
- Scrape by with minimal day to day expenses
- Skip other essential bills to pay more on the mortgage
Learn More About Paying Off Debt
Reducing your debt is a big challenge but it is possible. Understanding the amount you owe and the details of each of your loans can give you the information you need to successfully pay down your debt. As you reduce your debt, remember to practice responsible spending so you don’t end up overwhelmed in the future.