8 Methods of Paying Down Debt

Debt puts a strain on the average American income and makes it difficult for families to reach financial goals. Debt repayment causes families to delay important milestones, such as buying a house or planning for retirement. And without a strategy to tackle debt head-on, your debt balance can balloon and become unmanageable. Whether an emergency purchase caused you to carry a balance on your credit card or you’re so deep in debt you can’t make your minimum payments, now is the time to choose a strategy that will make debt repayment easier. Outstanding consumer debt continues to climb, especially in the wake of a pandemic that left 15 percent of Americans in a worse financial situation than before. Americans now owe a whopping $14.19 trillion in non-housing debt, according to the Federal Reserve Bank of New York. That’s about an average of $16,210 per person in debt from home equity lines of credit, auto loans, credit card debt, student loans, personal loans, payday loans, and more. If you’re like the average American, you probably have a long way to go before your debt disappears. Here’s what you need to know to get out of debt quickly and safely.

How Debt Affects Your Finances

Your credit utilization ratio, which represents how much of your available credit you’re using, accounts for 30 percent of your FICO score. It’s the second most important factor in determining your credit score. To achieve a good credit score, you want to keep your credit utilization ratio below 30 percent. If you’re using more than 30 percent of your total credit limit, that’s a sign to lenders that you’re overextended and more likely to default than your peers. And if you want an excellent credit score that will qualify you for the lowest interest rates, you’ll need to keep your credit utilization ratio under 10 percent. Having a lot of debt can bring your score down, which will impact your likelihood of being approved for new credit with the most favorable rates and terms. That will drive up the cost of future borrowing. For example, getting an auto loan with bad credit could double the cost of purchasing a car. Furthermore, most lenders will look at your debt-to-income ratio to assess the risk of lending you money. Generally, you won’t be approved for a mortgage if you’re spending more than 43 percent of your income on debt repayment. And since debt leaves you with less income, it will also hinder your savings goals. After you make your minimum payments and cover your necessary expenses, you might not have enough money leftover to stock an emergency fund or retirement account, which can leave you more vulnerable to financial hardship in the future.

The Dangers of High-Interest Debt

High-interest debt can get out of control quickly, especially on short-term loans like payday loans and title loans. That’s because debt accrues compound interest and grows exponentially. As a result, the average payday loan borrower pays $520 in interest and fees to rollover a $375 payday loan for five months. Title loan borrowers also end up struggling to repay their loans; one in five title loan borrowers have their vehicles seized due to default. Some high-interest debt is safer than others. An installment loan with a longer repayment term and no prepayment penalty leaves a borrower better equipped to manage paying off debt than a payday loan or title loan. And some installment lenders report on-time payments to the three major credit bureaus, which can help you build credit. Still, anytime you borrow money, you need to be aware of the APR and have a plan to pay back the loan within the term.

8 Methods of Paying Down Debt

Budgeting

If you’re just dealing with a small amount of debt, reevaluating your budget can go a long way in helping you pay it off faster. Start by adding up your sources of income. Subtract your minimum debt payments for each loan or credit card. Next, subtract recurring bills like rent. Your next step is to estimate how much you’ll need to spend on groceries, utilities, and other necessary expenses. Any leftover income can go towards debt repayment. You may have to skip dining out or going to the movies for a while, but once you’ve repaid your balance, you can start devoting your income to things you want. You can also combine budgeting with the debt avalanche or debt snowball method to make repayment easier.

Debt Repayment App

If you want to make some headway on your debt without thinking about it, try using a debt repayment app. Some apps use your spare change to pay off debt, so you’ll make progress as you spend on everyday necessities. Other apps use machine learning to determine how much of your income can be safely devoted to debt repayment. And still other apps calculate the fastest repayment plan given your debts. Basic budgeting apps can also help with planning. Take advantage of technology and research apps that might make it easier for you to get out of debt quickly.

Debt Avalanche

Once you’ve figured out how much of your income you can devote to debt repayment, you can apply the debt avalanche strategy. This is mathematically the fastest and cheapest way to get rid of your debt. You start by making the minimum payments on all your debts, and then you apply any extra available income to your highest interest debt balance. To use this strategy, make a list of all your debts in order of APR. It might look something like this:

Type of Debt	APR	Balance	Minimum Payment
Installment Loan	100%	$1,000	$50
Personal Loan	30%	$8,000	$300
Auto Loan	10%	$5,000	$200
Student Loan	4%	$12,000	$300

Let’s say that you have $1,000 to put towards debt repayment every month. After putting $850 towards your minimum payments, you have an extra $150 to devote towards debt repayment. You’d then make a $200 payment ($150 + $50) on your installment loan and minimum payments on the rest until the highest interest loan is completely repaid. Once that loan is off the list, move onto the next. Be sure to update the balance and the minimum payment each month.

Debt Snowball

If you’re the type who is motivated by crossing items off your to-do list, you might prefer the debt snowball strategy. While it will cost more in the long-run than the debt avalanche strategy, you’ll be able to reduce the number of outstanding loans you have more quickly. With the debt snowball method, you’ll list your debts in order of smallest to largest balance, as follows.

Type of Debt	APR	Balance	Minimum Payment
Installment Loan	100%	$1,000	$50
Auto Loan	10%	$5,000	$200
Personal Loan	30%	$8,000	$300
Student Loan	4%	$12,000	$300

You’d start by making extra payments on the installment loan until it is completely paid off, and then move onto the auto loan. Repeat the process until all of your debts have been repaid.

Balance Transfer

If you can qualify for a 0% introductory APR credit card and you don’t have more debt than you can pay off in 18 months, a balance transfer can be a great way to save money on interest. You’ll typically pay a three to five percent balance transfer fee to move your debt balance over to a new card, but then you’ll get a 12-18 month break on paying interest, depending on the card. Just make sure you evaluate your budget and have a plan to pay off the balance. Otherwise, the balance transfer card will just be a bandaid, and the problem will continue once the introductory period is up.

Debt Consolidation

Another option that’s only available to people with good credit is debt consolidation. This involves taking out a personal loan or home equity loan with a low interest rate and using it to pay off your high-interest debt. This only works if you’re able to get a lower APR than you have for your current debts. But if your credit score has improved since you last took out a loan, consolidating your debt could offer you a quicker way out of debt and save you a significant amount of money. It also streamlines your finances, since you’ll only have one payment to worry about per month.

Debt Management Plan

If you’re overwhelmed with debt and feel like you can’t handle it on your own, it’s okay to seek help from a nonprofit credit counseling agency. This is different from a debt settlement company. A nonprofit credit counselor will review your financial situation and let you know if you are eligible for a debt management plan, if you can tackle your debt on your own, or if you should file for bankruptcy. Under a debt management plan, you’ll make one monthly payment to the credit counseling agency, which will distribute the money to your creditors on your behalf. They’ll also try to negotiate a lower interest rate and waive some fees, so you can save some money on debt repayment as well.

Bankruptcy

If all other options fail, you can consider bankruptcy as a last resort. You may be eligible for Chapter 7 bankruptcy, which involves a bankruptcy trustee who will liquidate your assets and pay your creditors. If you’re not eligible for Chapter 7 bankruptcy or you’d rather maintain your property, you can file for Chapter 13 bankruptcy, which involves a strict, three to five year repayment plan. Both types of bankruptcy will discharge most debts, allowing for a clean slate. However, there are some major drawbacks to filing for bankruptcy. Some debts aren’t dischargeable in bankruptcy, and the process could result in you losing some of your property. What’s more, bankruptcy will have a devastating impact on your credit score for seven to 10 years. Having a bankruptcy on your credit report will make it nearly impossible to be approved for a home or auto loan. Since bankruptcy can get in the way of financial milestones, it should really only be considered in a worst case scenario.

Avoid Debt Relief Scams

If you have significant credit card debt or other outstanding debt, you could be vulnerable to debt relief service scams. Some debt settlement companies are legitimate, but there are no guarantees that they can settle your debt for less than you owe, and these for-profit companies may charge high fees if they are able to settle with your creditors. Others are fraudulent companies charging upfront fees for services that will never be rendered. It’s illegal to charge upfront fees for debt settlement, so if a company promises to settle your debt in exchange for upfront payment, it’s a scam. And if the company guarantees they can reduce the amount you owe, that’s also a red flag. If you think you’ve been a victim of a debt relief scam, you should report the scam to the Federal Trade Commission.

Stay Out of Debt

The best way to avoid unmanageable debt is to refrain from borrowing money. And the best way to ensure you always have enough on hand is to save a portion of every paycheck. Low-income earners need to be especially conscientious about stashing away cash in an emergency fund, since they have less disposable income to handle an unexpected expense. To ensure you’re saving enough for emergencies and for your future goals, financial experts typically recommend paying yourself first. That means you should devote a portion of each paycheck to your savings before you spend any money. Using automated deposits or a savings app can help put saving on autopilot, but you should still evaluate your budget each month to make sure you’re on track.