How to Get Out of Debt

Having debt looming over you can be extremely stressful and limiting. However, with the availability of credit, it is all to common for individuals and families to build up large debts. These debts can take many forms, including credit cards, car loans, and student loans. While we ideally want to eliminate all debt, it is important to realize that not all debt is created equal. You may have noticed that I did not include mortgages on this list. While a mortgage is debt, it is backed by collateral (the house). Therefore, a home can be seen as an investment because you expect the value of the home to appreciate.

Monitor Your Spending

The first step to getting out of debt is to monitor your spending to see where your money is going. One of the easiest ways to do this is utilizing a budgeting app. You can check out our article if you want help choosing the best budgeting app. Once you have a process established to track your spending, record every transaction. Ideally, you would follow this process for 3 months to be able to determine your average spending in each area (e.g. transportation, housing, food, clothing, restaurants, etc.). Once you know where all your money is being spent, the next step is to prioritize that spending by identifying unnecessary spending that can be reduced. For example, if you eat out twice each week, restaurants quickly add up, so you can reduce your overall expenses by decreasing how often you eat out.

Establish a Budget

Once you know where you are spending your money, establish a budget for how much money needs to be allocated to each category. Check out our “How to Create a Budget” article for help getting started. Once you have a budget in place, you must exercise discipline to stay within your budget limits for each category. A good practice, if you have key items or events you are saving for, such as a new dishwasher or a vacation, is to establish separate bank accounts that you contribute to each month. However, if you are focusing on getting out of debt, any unnecessary goals, such as that vacation, need to be put on hold. Once you get out of debt, you will be surprised how much faster you can save without making high-interest payments.

Increase Your Income or Decrease Your Expenses

Once you have tracked your spending with a budgeting app and setup a budget for yourself to limit excess spending, a way to quickly increase the rate a which you pay off debt is by either increasing your income or decreasing your expenses. You can increase your income by taking on an additional part-time job. Alternatively, if that is not an option, you can accomplish the same thing by reducing your expenses. For example, if your part-time job would have earned $300 a week, then you could alternatively cut spending by $300 per week. Almost all of us have some unnecessary spending on non-essential items. However, if you can do both, take on the part-time job and reduce your spending, that $600 per week will substantially increase your ability to pay down debt.

Pay Off the Highest Interest Rates First

When you look at interest rates, credit cards typically have the worst, so that is what you will want to pay off first. If you have a balance on multiple credit cards, then pay off the highest one first. Your billing statement will show the interest rate as an annual percentage yield (APY). If you had three credit card balances, you would need to rank the interest rates from greatest to least and start at the top. Once you pay off the highest interest rate credit card, move on to the next. When all credit cards are paid, start paying the next high-interest loan you have.

Pay More than the Minimum

Always attempt to pay more than the minimum payment. If you only pay the minimum, then the majority of your payment is going towards interest. This is especially true with credit cards. Your credit card statement will include a schedule of how long it would take you to pay off your current balance if you only pay the minimum. Look at this figure, and it will surprise you because it may take decades to pay down a loan. Thus, focus on paying more. If you have numerous debts, it may be necessary to pay the minimum on all of them except the highest interest rate debt so that you can contribute the maximum amount to paying off that debt.

Stay Focused

Paying off debt is rarely a quick process. Think of it as a marathon, not a sprint. As such, you have to create a program that you can sustain. If you are used to spending $500 a month on restaurants, you likely will not be able to immediately go to $0 per month, but you can still make drastic cuts. The key is consistency. It is better to be consistent at spending $100 per month at restaurants for three months, then spending $0 for months one and two, then spending $400 in month three. Even though you were doing great for two months, that third month resulted in spending $400, which is $100 more than you would have spent if you were consistent. Additionally, once you pay off your debt, you cannot forget about the budget or spending tracker. If you do, then the debt will slowly creep back up. Instead, make it a habit to pay off your full credit card balances each month. Additionally, automate your savings and investing by setting up automatic deposits. As soon as your pay check hits your checking account, money should automatically transfer to your savings and retirement accounts.