Effective Ways To Pay Down Your Debt

Effective Ways To Pay Down Your Debt

Dealing with debt is not fun. It's always front of mind and overwhelming to deal with, particularly if you have multiple debt accounts. When your debt gets out of control and the interest grows at a rate you can't keep up with, it will begin to affect your mental and emotional health. This is why there's no better time than now to take control of that mounting debt.

Note that among the highest debt accounts in American households, mortgage, auto loans, and student loans account for the bulk.  For the sake of this guide, we will not be covering mortgage debt; however, the same strategy can be applied if you ever decide to pay down your mortgage quicker. Auto, student, and credit card loan repayment can be addressed by applying any methods and strategies discussed in this article.

Despite the state of your financial situation, we're here to help. We created a comprehensive guide that will teach you strategies and methods to help get you become debt free and take back control of your finances. 

Understanding Your Debt Will Help You Pay it Off

Having the advantage of a birds-eye view over your financial situation will help you create the most practical repayment plan. 

The goal here is to pay down your debt and create a strategy that will ensure you decrease the overall amount of interest you pay. Below are a few ways to understand and take control of your debt. 

Analyze Your Personal Financial Statement

The first thing you will want to do is have an understanding of where all your debt comes from. Take note of every account, along with the debt totals. Additionally, you want to take note of the interest rates for each account. This will help you when you decide which accounts to tackle first. 

Additionally, you need to review the income side of your finances to help you understand what you can afford and what adjustments need to be made. You will want to have handy;

  • Credit card statements
  • Bank statements 
  • Utility bills
  • Rent/Mortgage payment statements

1. Design a Budget With Practical Yet Challenging Goals

This is a step you want to spend a little extra time perfecting to ensure you utilize your new budget to its fullest potential. 

So, you've reviewed your personal financial statement, and you calculated your total debt balance vs. your monthly net income. From here, you will create a comprehensive list of your monthly expenses, including all essential and non-essential categories. You can use the bank statements mentioned in the previous steps to help you complete this list. This is important in any budget to help you calculate the total balance you have after expenses.

For all your variable expenses (groceries, entertainment, miscellaneous, holiday spending, etc.), allocate a significantly reduced amount to these categories to squeeze up extra cash for paying down debt. Utilizing the cash stuffing system for your budget will help you stay organized and ahead of your spending because your money will be divided in their designated envelopes. See our guide on how to create a cash stuffing system for budgeting. 

From here, you should have a set amount of funds reserved for every single category, making sure all your fixed expenses are covered, and variable expenses are significantly reduced or omitted. All your cash surplus should go directly to your debt accounts. 

Suppose you’ve reached this point and all your expenses are divided accordingly, but now you're struggling with knowing what percent of your income each expense account for. An excellent method to follow is the 50/30/20 rule. This is a widely popular and accepted method used to help people divide their income between three main categories, allocating varying percentages to each. 

50% Must-Haves

The rule of thumb in the personal finance space is that no more than 50% of your net income (take-home pay) should go toward "must-haves." This includes;

  1. Housing cost (mortgage/rent)
  2. Vehicle cost and transportation
  3. Groceries
  4. Household utilities
  5. Insurance 
  6. Child care, if applicable 
  7. Minimum loan payments
    30% Wants

    This list consists of all non-essentials. Basically, everything you buy that you don’t need. This list includes;

    1. Leisure (eating out)
    2. Entertainment (including paid subscriptions)
    3. Gifts
    4. Travel
    20% Debt

    This category should never be neglected, particularly if your financial situation is not favorable. The 20% category includes a combination of debt and savings, covering;

    1. Paying off debt. Below we go over debt payment methods you can implement.
    2. Saving for an emergency fund and 3-6 months of monthly bills.  

    While this method is simply a reference point on how to divide your main expenses, it should undoubtedly be adjusted to yield more favorable results. For example, assume your "must-haves" only account for 30% of your income, and you manage to drop your "wants" down to 25%. To pay down your debts quicker, allocate the additional 25% entirely to your debt accounts, meaning 45% of your income will go toward paying down all your debt. 

    Monitor Your Cash

    While this step may be time-consuming, it will prevent you from overlooking problems in your budget, like overspending on specific non-essential categories.  Consider getting into the weekly or even daily habit of note-taking for all your spending. This will give you an accurate representation of where your money is going and where you can make adjustments to create a lean budget for the following month.  Remember, the more money you allocate to lump-sum debt payments, the quicker it will be paid down.


    2. Restructure Your Debt To Reduce Interest

    The purpose of restructuring your debt is to reduce the interest you’re paying over the long term. There are a few options you can utilize depending on your situation. 

    Consolidate Your Debt

    Simply put, debt consolidation means you would apply for a new loan to cover all your current debt accounts. The premise is to streamline your payments down to one, therefore, reducing the interest you would have paid from a variety of creditors.

    Banks and debt consolidation firms offer these services. Your bank should be your first option as they typically provide slightly more attractive interest rates. If your bank cannot extend credit to you, inquire with a debt consolidation firm.  Bear in mind, applying for a debt consolidation loan will cause an initial drop in your credit score, but if you follow the terms of payment, overtime it will build your credit. 

    Switch to a Low-Interest Credit Card 

    Credit card companies offer a spectrum of credit cards with varying interest rates. If your debt is not too large, you may want to consider contacting a credit card company with a low-interest card to apply to have your balances transferred over. You may even come across balance transfer promotions with 0% interest for one year, so shop around for that. In this case, take advantage of the promotion, transfer your high-interest balances over,  save a large lump sum payment and apply it directly toward the principle amount.

    Consider Using Home Equity

    For homeowners who are struggling to clear up debt, a home equity loan can be an excellent option. How this works is the homeowner would borrow against the equity in their home, which is the balance they've paid into their mortgage. Suppose you paid off $150,000 on your mortgage loan thus far; you can go to your bank and apply to borrow a percentage of those funds. Home equity loans are common and used for various expenses, even home renovations. Don't overlook this in a time of need. 


    3. Consider a Debt Payment Method

    A debt payment method should be applied rather than arbitrarily making payments, to make sure you’re saving on interest. Below are a few easy-to-follow and effective methods. 

    The Debt Avalanche Method

    The debt avalanche method is centered around tackling your debt by paying off high-interest accounts first. Suppose you have 4 credit cards with varying interest rates, including; 22.9%, 19.9%, 19.9%,  and 17.9%. 

    You would structure your payments in a way that you focus on paying down the 22.9% credit card first while ensuring you maintain minimum payments on the remaining cards. The objective of this strategy is to relieve the debt holder from high-interest debts as quickly as possible. A credit card with a large balance combined with a high-interest rate yields high interest payments. Saving this money can help you pay down other debts by allocating it to those balances. 

    If you have high-interest debt accounts, this method could be an excellent option for you. 

    The Debt Snowball Method

    In contrast to the debt avalanche, the debt snowball method concentrates on paying down the smallest balance before larger ones. The premise behind this method is psychologically driven.  Naturally, it's quicker to pay down smaller balances. Because people are driven by tangible results, they are more likely to stay on track when they begin clearing out small balances and feel a sense of achievement. If you're the type of person that finds motivation with every little win, this method could be excellent for you.

    Final Thoughts

    Paying down debt can feel like a burden because it often requires sacrificing other "fun" areas of our lives. However, if you take the time to analyze your financial statement and apply the most appropriate debt repayment method to your plan, the burden will only be temporary. The best part is, paying down debt opens up far more financial opportunities for your future, such as saving for retirement, investing, and affording vacations.