When you have the average amount of credit card debt, or just a mortgage or student loan, repaying debt by quickly paying off credit card debt and/or paying off debts with higher interest rates is a systematic approach that gets you out of debt relatively quickly. However, if you have many different debts or large debts, the amount may seem too overwhelming to even think about a plan beyond paying the monthly minimum payments.
Even if you have six-figure debt with high interest rates, you need to have a plan. The process of creating a plan may feel overwhelming, but not making a plan will just lead to a bleak future. Additionally, if your loans are so insurmountable that you decide to take more extreme action like declaring bankruptcy, it is better to make the decision sooner to start your journey to financial wellness sooner.
Assess All Debts and Calculate Your Monthly Minimum Payments
Before you can create a plan to pay off your overwhelming debt as efficiently as possible, you need to take stock of all debts you currently have. Even logging into accounts with large debts can trigger anxiety, but you have to do it. There is no way to improve your current financial situation without fully understanding what your current financial situation is.
Make a list of each debt you have, the total amount of that debt, the monthly minimum payment, and the interest rate on that loan. Your list will look different than anyone else’s list and have your specific debts, but here is an example:
Initially, the monthly minimum total minimum is the most important data point. In this table that is $1,400. This is the amount you absolutely need to find within your current monthly budget to allocate towards debt. If you pay less than the monthly minimum total, you will fall even deeper into debt. That is not the goal. Knowing that you need at least the monthly minimum total to pay your debt each month, the next step is to take a look at your spending habits to see how much extra money you can allocate towards debt repayment.
Determine How Much Money You Have for Decreasing Debt
In order to calculate how much money you can put towards your debt each month, you need to first calculate a typical month of expenses. Our expenses typically vary slightly each month, so looking at your spending habits over at least three months is ideal to see how much money you are spending on different categories. Assessing six months or a year is even better, particularly if you spend on purchases like an annual vacation or holiday gifts.
If you need specific assistance determining your typical monthly spending, Tori Dunlap’s Financial Feminist outlines how to track your spending over time. Alternatively, you can visit each account or source of money transfer you use and pull the statement from the last three, six, or twelve months. This means your credit card, checking account, Venmo, Zelle, PayPal, and any other accounts you have. Categorize each transaction into categories like “groceries,” “dining out,” “entertainment - sports,” “entertainment - movies,” “transportation - car,” or whatever else makes sense. Categories should be specific enough but also meaningful. For example, grouping together groceries and dining out may hide the fact that you are overspending on groceries and producing a lot of food waste or ordering takeout more than you actually need to in order to provide value. These categories should let you see where you spend money.
After categorizing, calculate the total of each category. Then answer this important question:
How much money is left over to pay off debt quickly?
For the example above, if the person calculated their monthly spending and found they had $1,600 left over for eliminating debt, the first $1,400 would go to the monthly minimum total. They would have an additional $200 to pay down debt quickly.
However, if they only had $1,200 left over, that would be problematic. It is crucial to find at least enough money to pay the monthly minimum total. If you cannot meet the monthly minimum total based on your first calculation—and truthfully, even if you can!—ask yourself the next question:
Are you happy with where you are spending your money?
Sometimes this question is easy to answer. You realize you are spending $500 a month on ordering takeout and picking up coffee and do not get a lot of joy out of it. You just feel tired and do not feel like cooking many nights of the week. Committing to cooking in bulk or even meal prepping once or twice a week can easily cut that $500 in half and bring you to where you need to be. Your obvious category may be completely different: clothes shopping, upgrading technology, Target trinkets, or purchasing Ubers rather than taking the bus can all be potential areas of overspending.
Other times this question can be difficult to answer. If you examine your budget and really value everything in it, there are a few different approaches. First, what do you value the least? If you are spending on going to NBA games, going out drinking with friends, and buying lunch when at the office rather than packing a lunch, which of those three areas of spending do you value the least? If you need to find even more room in your budget, only keep your most valued of the three. While you need some area of happiness spending in your life, you likely cannot fund every fun spending category while servicing overwhelming debt.
If you still cannot find room in your budget after eliminating all but your most valued area of happiness spending, it is time to revisit your needs costs. You need some happiness in your life, so do not eliminate all of it. Instead, research whether a more creative housing or transportation solution exists given your current life requirements. This may require difficult calls like getting a roommate or selling a car, but these decisions are worth it to get out of debt more quickly while still living a joyful life.
Even if you initially calculate how much you spend in a month and can meet the monthly minimum total, you can also eliminate some fun spending categories and/or reduce your needs costs to pay off your debt more quickly. This is a terrific way to get ahead and get out of debt. However, make sure you keep at least one category of fun spending to give you joy.
Set Up a Payment Plan
Once you identify how much money you can put towards your debt, set up payment plans. Set up automatic transfers for each monthly minimum payment from your checking account to each account with debt. You never get to touch this money or even think about spending it elsewhere. This is money to pay off your debt and make sure your debt does not grow out of control!
Next, identify the loan with the highest interest rate. In the example above, it is the credit card with a 30% interest rate. Use any money beyond the monthly minimum total that you have earmarked for debt payment to pay off the principal of this loan. For example, if I had the debt listed above and identified the $1,600 in my monthly budget, I would pay the following amounts towards each loan:
Keep putting all extra money towards the loan with the highest interest rate until the loan is paid off in full. Once it is, move to the loan with the second highest interest rate, then the third, until all debts are paid in full.
Verify that Additional Payments Go Towards the Principal
Some lenders are sneaky and will apply any extra payments beyond the monthly minimum to interest rather than the principal. You want your extra loan payment money to go towards the principal. This will prevent interest from accruing on the portion of the principal you pay off early, saving you money by accumulating less interest over time. If the format of your lender’s website does not make it clear whether your additional money is applied to the principal, it is worth calling to verify that all additional payments go towards paying off the principal.
Stick to the Plan, but Celebrate Achievements
Paying off overwhelming debt is a long process, so you need to celebrate your wins along the way. In the example above, after paying off that credit card and eliminating the $200 monthly minimum associated with it, congratulate yourself! The first month after eliminating your credit card debt, take that $200 and do something fun with it, but do not inflate your lifestyle. Choose a one-off activity that you will remember and associate with debt repayment to motivate you to pay off your next debt. Do not add a $200 recurring expense to your lifestyle. That $200 can now go towards paying off other debts faster.
As you pay off debts without adding expenses, you will notice your debt repayment accelerating because there are fewer monthly minimum payments. When you eliminate the $200 minimum on the credit card, you then have an additional $200 when paying off the next loan! In the example above, if you allocated $1,600/month towards debt repayment, this would now mean paying the monthly minimums for the car loan and student loan and putting $400 extra (the total amount you previously paid towards the credit card) towards the student loan repayment. That is twice the former monthly minimum credit card payment because there is no more credit card payment!
If you are starting with overwhelming debt, by the time you work down to one remaining debt, your debt repayment will go faster than you could have imagined at the beginning.
Bonus Step: Raise Your Income without Inflating Your Lifestyle
In addition to finding room in your budget, increasing your income can help pay off debt more quickly. If you accept a job with a $12,000 net increase in salary or start a side hustle netting $1,000/month, you just found another way to increase your debt repayment by $1,000 each month. Raising your income without inflating your lifestyle is one of the best ways to accelerate debt repayment.
“Without inflating your lifestyle” is important. It can be tempting to add expenses when you add income to your life. Do not do this while you are servicing debt. You should still have an area of happiness spending to keep you sane. Beyond that, wait until your debts are paid off to spend extravagantly.
When Debt Truly Feels Impossible
If you truly cannot find the room in your monthly spending to meet the monthly minimum total, it may be time to declare bankruptcy. Before making this decision, consult with a financial professional and consider your financial situation thoroughly. Bankruptcy is not a decision to take lightly, and you should also have a plan to improve your financial situation after bankruptcy before you go that route.
To be clear, if you have not categorized every dollar spent in the last year of your life, you are not ready to make a decision around bankruptcy. If you have not added up the total spent in each category of your life, you are not ready to declare bankruptcy. If you have not considered which areas of spending you can eliminate, you are not ready to declare bankruptcy. If you have not considered alternative housing or transportation solutions, you are not ready to declare bankruptcy.
Math comes before bankruptcy. Do not follow the bankruptcy path out of fear of math or laziness. Bankruptcy is the last resort. For those that need it, it can be a useful solution to start over financially. For others, it can just create new problems in rebuilding credit and setting up new financial accounts. If you believe bankruptcy may be right for you, please verify that you have fully explored your spending and consult a financial professional.
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