The Downfalls of Debt
Eliminating debt as quickly as you can is one of the best ways to be smarter with money. Debt accrues interest, so the longer you carry debt, the more in debt you become. And if you find yourself ignoring your debt obligations completely, you will become even further in debt from late or nonpayment penalties, on top of ever-accruing interest. Making the problem even worse over time. And that's just the start of the downfalls.
Debt restricts your ability to use your money on things you want or need in the future. And debt makes it harder to even qualify for future wants or needs, like a home or a new vehicle.
Having debt can also limit your choices in life, whether it's embarking on a new career path (where you likely have to start from the bottom to work your way up, but can't afford that luxury), or going back to school to enhance your career options (because the idea of adding even more debt to the pile terrifies you). And of course, the big one, debt makes the proposition of starting a family seem that much more daunting or unrealistic. Debt can even make plans to relocate to a different state or even just to a different neighborhood seem like less of an option.
Then there's the psychological toll debt plays on a person. Debt is one of the leading causes of stress for most people, and it leads to much higher levels of general anxiety; having debt can outright rob you of ever feeling fully safe and secure.
Some Debt is Acceptable, But Only in the Short Term
It's not that you should strive to never carry any debt whatsoever. The focus of this guide is more on addressing crippling long-term debt, the kind where the amount is so heavy and burdensome that the sheer weight alone restricts your life in all the worst ways.
It is OK to get a mortgage or an auto loan, or even take out a student loan. These are known as 'good' debts because something good comes from them if all goes well, like eventually owning a home or vehicle outright (gaining equity) or gaining more accredited education to further your career, which likely raises your earning potential for the rest of your working life. On the other hand, 'bad' debt is debt that has no upside, like credit card debt.
But no matter what debt you carry, good or bad, you should always have a clear path to eventually be free of all of it. Even if you are not feeling the crippling effects of it right now, debt, even in the guise of monthly mortgage or car payments, has a way of limiting your options.
If you make a lot of money, but also spend a lot of money on recurring loan payments that accrue interest, you have to keep making roughly the same amount of money until those accounts are paid off. Which at least in some respects, makes you beholden to your debts and therefore restricts your freedom. And if you don't make much and have massive debt, you can rightly feel like you already lost at the game of life, at least as far as credit and finances go.
So to avoid compounding interest, to have more money and financial opportunities in the future, to have less limitations going forward, and to just save your sanity, it's a wise idea to eliminate all of your debt as quickly as possible, and to make it a top priority.
Smart Ways to Approach Paying Off Your Debt
Paying off debt isn't necessarily a 'one-size fits all' proposition. Depending on your financial circumstance and monthly obligations, it might not make sense to use every bit of your extra earnings toward just paying off debt. In some cases it can make sense to also invest or sure up savings accounts at the same time. And if you are thinking or saying 'I don't have ANY extra money to put toward eliminating debt right now', the next sections might be able to help you out with that.
Caveats aside, when it comes to paying off your debt, first declare tackling it a top priority. Then understand how much money you earn and spend monthly, and therefore how much you could have leftover to use toward paying down debt. And then try and make that leftover amount as big as possible by tweaking your monthly budget, and resolving to stick to those changes. Once you know your leftover amount, apply that to your debts one at a time until they are all eliminated. That's the recipe to become debt-free. Once you take on more debt in the future, simply rinse and repeat as needed.
#1 Know Your Monthly Income After Taxes
You should know exactly how much you make from your income every month, after tax obligations, to know exactly how much you are able spend on your monthly expenses, and then ideally and if possible how much you can put toward debt elimination. This step is by far the easiest and just involves you and/or your household looking at paycheck stubs, and finding your total earnings after taxes are taken out. This includes income earned from main jobs, side hustles, dividend earnings, or any other passive income you have coming in. Just add it up and work from that amount for the next steps.
If your income fluctuates monthly, if you are in sales for example, find the average you make in a quarter historically, and divide by 3. Or whatever makes the most sense for you. Just low-ball your earnings if they aren't set in stone because it's always better to assume you might not get that year-end bonus or raise, than to count on it and be wrong.
#2 Know Your Debt & Write It All Down In One Place
Now look at all of your debt, all at once. This is the least fun task, sorry.
You can either write down all of your outstanding balances on a sheet of paper. Or use a computer program like Excel, Google Sheets, or any number of finance apps or money management tools.
It might take you a while to track everything down, especially if you have made it a practice to mentally avoid looking at your debt for a long time. But writing everything down oddly comes with it a sense of peace. Your debt is no longer this vague thing that's scattered all over the place. Instead, here it all is, in a nice neat little list.
Whichever route you go to visualize your debt, it's imperative to be able to see ALL of it with the most updated info. You should include:
- List of all your Debts
- Current total balances of each account
- Type of debt (Credit Card, Student Loan, Auto Loan, Mortgage, Medical, Tax Debt, etc)
- Current interest rate each account accrues
- Minimum monthly payment of that account
- How long you have left to pay off that account if paying just the minimum every month
Now that you know your earnings after taxes and your full debt picture, you can square all that with your monthly budget and determine how much (if any) you can put toward paying off your debt.
#3 Spend Less Than What You Earn, Budget Wisely
If you have a budget you use monthly, that's great. If you don't, it's smart to create one. You should be able to see at a glance exactly where your money goes, on a regular basis - whether that be weekly, bi-weekly or monthly, whatever makes sense for you. For the sake of this guide, let's stick with monthly intervals, as that's how most recurring payments are due.
What matters most is knowing exactly how much is coming in, and more importantly, how much is going out.
Many people create budgets but have a hard time sticking to them. And that's totally understandable. In large part this is because when we sit down to do a budget we aren't exactly honest with ourselves on what we actually spend. Or even worse, we have no idea what we spend on things like food, gas or entertainment any given month. And maybe we are even scared to look.
So to create or tweak an expense budget into something that's realistic, it's best to be as honest and realistic as possible. Either using a computer, phone app, or a paper and pen, write or type down all of your expenses for the month.
Start with the expenses that are fixed, that won't change from month to month such as:
- Rent/Mortgage (and factor in HOA fees, property taxes, etc)
- Car payments
- Fixed utility expenses (cable, internet, cell phone, etc)
- Insurance (health, auto, rental, house, etc)
- Subscriptions (Netflix, Hulu, Amazon Prime, etc)
- Credit cards, minimum monthly
- Student loan payments
- Back tax debt
- Alimony
- Child support
- Any other monthly recurring charges
- Investments
- **Emergency savings accounts
**Having an emergency savings account is also a very important part of a sound budget, and a smart way to continue to stay out of debt. You never know when unexpected expenses will come up, you just know that it will happen. And if you don't have any savings you will be tempted, or have no choice to incur even more debt, that accrues more interest and makes your debt situation worse. So plan to set aside a small amount every paycheck for an emergency savings until it reaches an acceptable amount, which is typically $500 to $2000. $1000 is an excellent goal. Then you can add small amounts to it periodically.
Now do your best to understand how much you typically spend on expenses that can change, based on your tastes and habits. Once you figure out your normal range (ideally by looking through your bank account and credit cards to see the actual numbers), consider putting the highest end of that range in your budget.
It's always better to estimate your spending habits on the realistic high end, not the aspirational low end, to avoid going over your budget every month.
Now budget for --
- Food
- Utilities like electricity, water, gas, trash
- Household items (detergent, toothpaste, paper towels, etc)
- Gas (for driving)
- Childcare
- Entertainment (going out expenses, alcohol, theater tickets, video games, etc)
- Misc Expenses (everything else, clothes, trips, furniture, date nights, home repairs, car repairs, oil changes, etc)
- Any other expenses you can think of
Once you have a good idea of what you spend your money on every month, and exactly how much you spend, add it all up. And then subtract that number from the amount you earn every month after taxes. What's leftover? Anything? Are you perhaps realizing you spend more than you make?
If you don't have anything leftover, or even worse, are typically spending beyond your income every single month, this is a perfect opportunity to adjust your spending habits. Best option here is to go back over your budget and start shrinking down or eliminating anything you don't have to spend money on. Or that you can spend less on.
Most people can save money by eating at home more, by cancelling subscriptions they can live without, and by cutting down on entertainment and misc expenses in general. In some cases, you can also look to downsize or move, to get cheaper rent or a cheaper mortgage.
Even before you start paying off your debt, it's first most important to live within or below your means. Meaning simply to not spend more than you actual earn.
Of course the other side of the equation is to attempt to earn more money than you currently bring home, to be able to afford more, or to be able to eliminate debt faster. Easier said than done, but certainly also an option to explore, especially if you conclude your budget can no longer shrink any further and the numbers still don't add up.
OK. Let's assume you went back and adjusted your budget and now you have a budget you can stick to, that provides some leftover money every month you can put toward paying off debt. That's great. Now just look back on your big picture debt list, and develop a plan to pay each account off completely, one at a time. And also declare you are fully willing to use this 'extra' money towards those debts, realizing this plan is a means to a worthy end.
#4 Develop A Plan -- Avalanche vs Snowball (Your call)
If you are already paying the minimum monthly on all of your outstanding balances, then you're in a good place to pay more to speed up the debt elimination process. If you aren't, your first step should be to reach out to collection agencies and work out a payment arrangement with them. But also consider that certain debt falls off of your credit after 7 years of inactivity. So if you have an outstanding balance and it's several years old, weigh the pros and cons first; it might be smart to just wait out the 7 years, depending on the type of debt and how much it's effecting your credit.
Once you are making payments on all the accounts you have open (or all the accounts that make sense to pay on right now) it's time to decide which debts to put your energy into paying off first.
There are many methods on how best to generally tackle debt, but two of the most popular and useful are the debt snowball method and the debt avalanche method. Both have their pros/cons, but both ultimately achieve the same goal.
1) The snowball method focuses on paying off accounts with the smallest balances first
2) The avalanche method focuses on paying off accounts with the highest interest rates first
So it's really up to you which one you want to go with. If you have more accounts in debt, you might lean toward #1. That method has more instant gratification and might increase your credit score faster. But if you have accounts obviously accruing more interest than others, you might lean toward #2. That method typically saves you the most money in the long run, as less debt interest can accrue with all your accounts overall. Or if you have a plan of your own, that's perfectly fine as well, as long as it results in debt elimination.
It's worth playing around with debt payoff calculators to find the math that's best for your unique debt situation.
Depending on your financial situation, this will obviously take some time and is no magic fix. But sticking with it, you will see results more and more, much like a snowball gaining in size and speed as it rolls down a mountain, or an avalanche growing in size and speed the further it has to fall. You too will gain momentum and sleep better the more you eliminate your debt using either method. It just requires knowing your full debt picture, creating a proper plan and budget, and sticking to that plan as best you can until the debt is fully gone.
#5 Negotiate Lower Interest Rates, Better Payment Plans
Once you know your full debt picture and have developed a plan to tackle your debt accounts head on, one by one, you can also reach out to the companies or debt collection agencies that own your debt and attempt to negotiate better repayment options.
Depending on the kind of debt it is, if the debt is in collections for example, debt collection agencies are motivated to work with you to help you pay that debt as quickly as you can. So simply call them and ask if they would be able to lower your interest rate if you agree to pay the debt off sooner. Or better yet, if they would settle for a smaller total amount if you paid the account off in full, either in one go, or on some expedited payment plan. You would be surprised at how much you can save if you open the lines of communications up with your debt holders.
Of course that doesn't work for all kinds of debt. You won't be able to re-negotiate tax debt or student loan debt terms and conditions for example. But even with those it's worth researching deferment programs or other low-income programs if you make under a certain amount. And you can always look into refinancing student loans, consolidating higher interest loans into a single, lower interest loan. Just keep in mind that option is usually reserved for those with good to great credit. So it might not be an immediate option, but the further along you get with eliminating debt, the better your credit will be, the more likely you can lower your interest. And therefore the snowball/avalanche happens even faster!
#6 Balance Transfer Cards, Debt Consolidation
You can also consider opening up a balance transfer credit card, as a way to take advantage of low or 0% introductory rates on the new card, so you can transfer credit card balances (or many other types of debt) with high interest rates into a credit card with little to no interest, and pay off the new card before the introductory rate expires.
Just be aware you will incur a balance transfer fee of some kind, in most cases. And your credit could take a hit from opening up a new account. But this route can save you hundreds or even thousands on interest in the long run.
Debt Consolidation companies might also sound like a tempting solution. And don't get me wrong, they can help you. But unless your debt is completely out of control (rarely the case), you can avoid paying a debt consolidation company hundreds or even thousands in fees by just tackling your debt head on yourself.
#7 Avoid Credit Card Debt Going Forward
Last but not least, as you are eliminating debt, it's also very important to not accrue any more debt going forward. So if you have credit cards, simply stop using them. Or if you do use them for points/rewards, make absolutely sure you pay off the balances within the month BEFORE it is able to accrue any interest charges. Interest charges are what you want to avoid, at all costs.
In Conclusion, Debt Elimination Benefits
To conclude and recap -- once you know your monthly income after taxes, exactly how much debt you have and all its details, you have created a successful and realistic monthly budget, know exactly what you have leftover financially to put toward debt, and have isolated the debt you want to tackle first, you're well on your way to fully eliminating all of your debt, with a plan to also not make the issue worse, by avoiding credit card debt going forward.
The benefits of debt elimination are numerous and include:
Credit score increases. Less (or zero) debt increases your credit score pretty dramatically in a number of ways. And a better credit score or credit report can qualify you for lower interest rates, less or zero deposits on all kinds of applications, and better/bigger auto, mortgage and possibly even small business loans in the future. And maybe even access to better careers, if they look at your credit (some do now).
Just try to avoid the circular thinking and pitfall of eliminating old debt just to jump into new shiny debt.
You have more money to spend every month. Once you pay off accounts you had been paying just the minimum on every month, you can now take that account off of your budget, therefore giving you extra money with your budget to spend on whatever you want. Or save if you like.
Stress/Anxiety decreases. This isn't a psychology blog, but know there are a zillion and one articles online detailing very plainly that debt causes all kinds of stress and anxiety, and getting rid of it does the exact opposite.
You have more freedom and choices. Not being saddled with debt gives you more freedom. You can live more modestly if you want, as you don't have to earn as much anymore now that your budget is lowered by removing debt payments. Or you can more easily start a family or save for your children's future education. Or.. whatever you want really. You can more freely go more places, make more big changes, or do less, all because you have less obligation to put resources toward paying off debt.
Debt is an unnecessary weight on all shoulders that carry it around. It's very smart to eliminate it as quickly as you can, and enjoy all the benefits that come from being unburdened by it.