Paying Off Debt: A Plan
Some of us start our journey to Financial Stability at different places in life. We may have no credit and no debt or we may have a long credit history and large amounts of debt. Or we may be somewhere in between. Debt can be a big barrier to being financially stable, but paying off your debt definitely is doable. So let’s do this!
Paying off debt simply requires a plan
- Starter Emergency Fund: Make sure you have $1,000 in savings as your Starter Emergency Fund. This money is on reserve to ensure any small emergency doesn’t derail you while you are in Budget and Debt Repayment mode.
- Gather up all your debt: You might have done this when you began Tracking your Spending, but if you haven’t yet, go ahead and list all your debt out on a piece of paper. Include total amount owed, monthly minimum payment amount, interest rate, monthly due date, and final payoff date (if you have a payment plan in place). Also include any amounts you may owe friends or family members, and include your car payment and your mortgage payment. It is eye-opening to see how much we owe everyone. (Note: You may need to pull your credit for this, or call some of the banks/creditors and ask for this information if you didn’t keep any of the paperwork.) Leave no stone un-turned.
- Look at your budget: Determine how much money you have in surplus at the end of each month. You may decide while you are in serious Debt Repayment mode, some things on your budget need to go. If you have $50 a month earmarked for coffee, or lunches out, you may decide to reduce that amount or eliminate it entirely. Or not—this is definitely your budget and you are the only one who decides what is valuable to you. Re-evaluate essential expenses and non-essential expenses and come up with an amount that is your surplus. *A surplus: The difference between what you spend and what you earn. If you do not have a surplus, but you have debt, you may need to trim the budget and be sure you are only spending on essential items. If you have trimmed all you can trim, and still do not have a surplus, you may want to consider picking up a side job (babysitting a couple times a month, or a second job) so you can have some extra income to go toward your debt.*
- Divert your entire surplus toward your debt: This is the point where you decide which debt you will pay off first. There are a couple different methods you can choose, and there is no right or wrong.
- Avalanche Method: Pick the debt with the highest interest rate, and shove all your surplus toward this debt, every month, until it is paid off. Attacking the debt with the highest interest rate may save you tons of money in additional interest payments if you get it off your books. The name implies, once you knock off the debt with the highest interest rate, your Debt Repayment will begin an Avalanche, eliminating debt quicker because of the money not unnecessarily paid toward interest.
- Snowball Method: Pick the smallest debt, and shove all your surplus toward this debt until it is paid off. Attacking the debt with the lowest dollar amount owed may bolster your confidence because it knocks down the number of creditors on your list faster. The name implies, once you knock off the smallest debt, you can roll that minimum payment into your next largest debt (like a snowball), and by the end of your list, you will have a large amount rolled together to tackle your largest debt.
- You will always continue to pay the minimum payment toward all debt while you are practicing either of these methods. This helps avoid any additional fees or penalties for late payments which would only increase the amount you owe.
- With either of these methods, when you pay off a debt in full, you will then roll that payment into your surplus and it will free up available money to go toward debt repayment. For example, you were paying $20/month to a Furniture Store for items you purchased on a payment plan. If you pay that debt off in full (either through the Avalanche Method, or the Snowball Method), you now have an extra $20/month freed up in your budget to be put toward the next debt on your list.
- Methodically pay off your debt: Whether you do Avalanche or Snowball, rinse and repeat until all debts are paid off. Depending on how much you owe, this could be a years long process. It was for me, and that is ok. Remember how important persistence is to your future of Financial Stability. As daunting as it may feel, you will thank yourself when you are finally debt-free.
- Emergency Fund: When you become debt-free, begin throwing that surplus, and all the money you were previously putting toward debt repayment (minimum payments, etc.), toward building your Fully-Funded Emergency Fund (3-6 months of expenses).
Anything interest-free: if you aren’t paying interest on the debt (sometimes stores will offer promotional interest-free financing), there may not be a rush to pay off the debt. If you would feel better having it all paid, by all means go for it, but the urgency doesn’t exist in the way it does for the debt that carries an interest payment as well.
Your house: This is absolutely debatable, so if you disagree with this, feel free to attack your mortgage in the same way you have attacked all other debts. At this point, the only debt my husband and I have remaining are his student loan payments and our house. We are on track to have the student loans paid off this summer. The debt we have already paid off together includes my IRS bill, some outstanding medical bills, my car, and a few other odd debts. We are choosing to focus our surplus on fully-funding our Emergency Fund after the student loans are paid off, because we want to have that safety margin. I feel more comfortable doing this, as we never know what emergencies could happen, but it ultimately is a matter of opinion and personal risk-tolerance.
Retirement Accounts: Depending on how much debt you owe, how much you have in retirement, how far off you are from retirement, if your employer offers a match, etc. you may decide to hold off on contributing to retirement while you are paying off your debts. I didn’t, because the longer you are in the market, the more opportunity you have for your retirement investments to compound and grow, but that is a post for another day.
That’s The Plan
As you can see, there definitely is a plan and some design around debt repayment. However, there is also a lot of room for personalization and tweaking to suit your own circumstances. This may be a fast or slow process for you, but it is a worthwhile one for all of us. Come back to this article to keep yourself centered and on-track during the process. Eventually, the budget gets to have fewer line items, and the gap between how much we spend and how much we earn becomes larger when we aren’t diverting a ton of money toward minimum payments every month.
Above all, be patient and kind with yourself. You are worth the time and energy it will take to become debt-free. It is absolutely possible to rein in our spending and follow a budget that will lay out a plan to freedom from debt. I used to think I was terrible with money. As I slowly started to follow a budget, and spend money only on what I truly valued, I gained confidence and financial literacy. We can all do this together, and I am on your team. Onward and upward!