At MoneyHaus we are advocates for using credit wisely, however debt without a plan to repay means that you are far from reaching your financial goals.
Debt can be a source of stress and grief, causing you to constantly worry about your finances and regret the limits debt has placed on your life.
Fortunately, debt isn't a life sentence. You can (and should) make getting out of debt a priority. Follow these seven steps to take control of your finances and pay off your debt for good.
1. Know Your Debt
Getting out of debt requires that you change the habits that led you to debt in the first place.
Understanding the type of debt you have, and how it happened, can help you create a plan for paying it off and make it less likely that you will fall back into debt in the future.
Debt Due to Loans
There are some loans that happen naturally at certain stages of life.
Examples of these are: A loan to start a Small Business, A mortgage to buy your home, need an auto loan to purchase a new car, or take on student loans to fund your education.
These debts are not bad, and often have manageable interest rates and monthly payments. You must ensure that they are not currently taking up much of your income. You should be able to comfortably make your monthly payments and still have money to save and for discrepancies.
When your current debt load is almost as much as your current income, you may find yourself taking on other debt, either in the form of credit card debt or personal loans, to make up the difference.
Debt Due to Circumstance
Sometimes debt accumulates due to circumstances outside your control.
Examples of these are: Medical debt due to unexpected illness or injury, Debt incurred during a Maternity or Paternity Leave, Debt Due to Divorce.
These debts can be crushing because they come with high interest rates. Often, you are forced to take them on when your financial circumstances were already strained. And as you attempt to pay them off, they can eat into your income and require you to take on more debt, creating a debt spiral that feels impossible to escape.
Debt Due to Spending
Spending without thought can create its own debt, usually in the form of high-interest credit card debt. Living beyond your means, and committing to high ticket purchases you cannot afford are contributors to debt you could have prevented.
Once you accumulate debt due to overspending, you end up paying far more in interest and penalties than the actual value of what you purchased. This can tie up your income, requiring you to take on even more debt.
2. Take Control of Your Finances
Whether or not careless spending habits contributed to your situation, you will find it easier to start to pay off your debt if you keep close control of your spending and finances.
Take time to compare your monthly income with your expenses. Divide your spending into mandatory expenses, or needs, and discretionary expenses, or wants.
Mandatory expenses include things like:
Rent or mortgage payments
Transportation to/from work
Discretionary expenses include things like:
In order to start paying off your debt, your monthly expenses will need to be significantly lower than your monthly income. You may be able to achieve this just by reducing your discretionary spending.
Pay your bills on time to save money. Late payments usually trigger fees or service charges that can make it harder to reduce your spending. Where possible, automate your payments to come from your checking account.
If that's not enough, however, you may need to take further control of your spending by lowering your mandatory expenses as well. You can use tactics like:
Downsizing if you rent your home
Renting out a room or floor if you own your home
Choosing a cheaper cell phone plan
Splitting internet access with a neighbor
Choosing a less expensive health insurance plan
Looking for ways to cook cheaply, such as eliminating meat from your diet
Using public transit instead of your car
You can also look for ways to increase your income, even temporarily, such as:
Taking on a second job
Doing occasional gig work
Putting all your credit card rewards toward cash payments instead of points
Insisting that money you are owed, such as child support or alimony, be paid
Selling household items, jewelry, or clothing
Local pawn shops make it easy to sell your items for cash. However, you will likely make more money if you sell directly to other consumers through Craigslist, eBay, Etsy, or your local consignment shop.
Once you have reduced your spending as much as possible, create a budget. This will prevent you from accidentally overspending. You want to make sure your expenses stay below your income; otherwise, you will end up owing more money in the form of credit card interest or overdraft fees.
Reducing your spending as much as possible, and taking control of your finances with a budget, will allow you to put all almost your extra money toward paying off your debt.
3. Figure Out How Much Debt You Have
If you have more that one type of debt, it can be easy to lose track of how much you owe and how much you are paying in interest every month. But you cannot begin to pay off your debt until you know what those values are.
Make a list of all your debts, how much you currently owe, and the interest rate being charged. Use recent billing statements, canceled checks or bank statements, and your credit report to get a complete list of everyone you owe and the amount you owe. Be sure to include the minimum payment required for each account. This is the smallest amount that you can afford to pay on your debt every month.
4. Decide How Much You Can Afford to Pay
If you pay only the minimum every month, it can take years or even decades to finally pay off your debt. To eliminate your debt much faster, you’ll have to send more than the minimum payment to at least one of your accounts each month. A debt consolidation loan from MoneyHaus can help you consolidate all of your debt into one affordable payment.
Use your monthly budget to decide how much you can spend on debt repayment each month. Subtract your expenses from your income, including any irregular or periodic expenses that may pop up during the month. What's left over after you've covered all your necessary expenses is the amount you can spend on your debt. Use this amount in your debt plan.
Your monthly income is $4000 and your monthly expenses are $3500.
$4000 - $3500 =
$500 FOR TOTAL DEBT REPAYMENT
You have three debts with minimum payments of $50, $75, and $100 per month.
$500 - $50 - $75 - $100 =
$275 FOR ACCELERATED DEBT REPAYMENT
Pro Tip: If your income does not allow you to have any money left over for debt you should consider a MoneyHaus Debt Consolidation Loan. It will bring down your monthly payments and provide you with some cash float and relief immediately.
5. Put Together a Plan
Decide in what order you are going to pay off your debt. You can decide to prioritize based on the interest rate, balance, or some other criteria that you choose. You can also use additional debt management strategies to reduce your monthly payments or consolidate your debt.
Whatever debt repayment strategy you choose, stick to your plan and send payments on time every month to avoid additional fees and interest charges. Eliminating your debt completely can take months or years depending on the amount of debt you have and the payments you make. Consistency with your payments is a necessary part of getting out of debt.
The Snowball Method
Using the Snowball Method, you pay off your debts from the smallest to the largest.
The "Snowball Method" is a term coined by Dave Ramsey. The name refers to the strategy of starting with something small and building it into something bigger, the way a snowball is made.
Make the minimum payment on every debt, then put any extra funds you have toward the debt with the smallest balance. This will be the one you can pay off most quickly, allowing you to see immediate progress on your debt repayment.
Once this debt is paid off, move onto the next smallest debt on your list, while continuing to make the minimum payment on everything else. You will have more money to put toward paying off this debt because you now have fewer minimum payments to make every month.
Continue until you have paid off all your debts.
The Avalanche Method
This strategy focuses on prioritizing debt by interest rates.
The higher the interest rate, the more a debt will cost you over time. Eliminating the debt with the highest interest rate will allow you to save the most money in the long run.
This method is the opposite of the Snowball Method.
Make the minimum payment on every debt, then put any extra funds you have toward the debt with the highest interest rate. Once this debt is paid off, move onto the next highest interest rate, while continuing to make the minimum payment on everything else.
Student Loan Adjustments
If you have student loans, you may be able to have the amount you owe adjusted based on your income or financial situation, particularly if you have loans from the federal government.
Once you have eliminated your other debts, you can start to make higher payments on your student loans.
If you are having trouble managing too many debts, you can consolidate them into a single debt. This is a secured low interest loan that covers the cost of your current debts, leaving you with only a single payment every month.
Consolidation does not eliminate your debt, but it does simplify it. Speak to a Credit Counsellor at MoneyHaus to find out if this is a good option for you.
6. Start Saving for a Rainy Day
As you work toward paying off your debt, you should also start to put money away in and an emergency fund as well. Building an emergency fund gives you more flexibility to handle surprise expenses, which makes it less likely that you will go into debt again in the future.
7. Don't Create More Debt
Creating debt while you're trying to pay off debt will hurt your progress and create more interest that you cannot pay off. While you are attempting to pay off your current debt, avoid using your credit cards, opening new credit accounts, or taking out new loans.
You can estimate the time it will take you to become debt-free by using a debt repayment calculator. Some let you enter a specific monthly payment or a debt-free deadline to customize your repayment plan.
8. Know there will be Setbacks
It may not be smooth sailing on your path to debt freedom.
A financial emergency could require you to cut back on your increased payment for a few months. You may find yourself needing to use credit cards or take out a personal loan to handle an unexpected situation.
When that happens, recalculate your budget and pick back up with your payments as quickly as possible.