If you know the basics of personal finance, you may already know the most powerful force in the financial universe is compound interest.
With compound interest, it’s easier to grow wealthier over time as the interest you earn compounds on itself repeatedly. Unfortunately, compound interest can just as easily work against you as it can for you.
If you are in debt, this force is working against you.
If you need proof, grab a copy of all your bills and do a quick exercise to see how much interest you are paying on the debt.
Basically, lay all of your bills and balances on your kitchen table and tally up the total amount of interest you’re paying on every balance you owe from your credit cards to your car loan and mortgage.
The result will probably shock you and hopefully motivate you to learn how to get out of debt once and for all!
Unfortunately, facing a mountain of debt is never an easy task.
It can be confusing to decide where to start and how to reduce your debts – after you’ve taken the time and built up the courage to figure out how much you owe. Thankfully, there are a lot of great resources to help you make these decisions.
I have a great resource on my site for you to reference on the teachings of Dave Ramsey, who specializes in getting out of debt, staying out of debt, and planning for a prosperous future.
The lessons are about his Baby Steps to Financial Peace. Reading the entire Dave Ramsey’s Baby Steps series is a good place to start to get some great ideas on how to get out of debt and become financially free.
But if you just want to get right to it, you can follow along below.
How to Get Out of Debt, A Practical Guide
The principles that help people get their finances in order and pay down debt are easy in theory but not simple to master in practice. Like building wealth, it takes time and dedication to pay off debt once and for all.
The basic principles of getting out of debt are:
- Recognize the Debt Problem
- Committing to Paying Off Debt
- Getting Support
- Establishing an Emergency Fund
- Accelerating Debt Payments
- BONUS: Advanced Methods
Now that we know which principles we’ll cover, let’s dive in and learn exactly how to get started and the best first steps to take.
Recognize the Debt Problem
One of the most important aspects of making any lifestyle change is recognizing the need for change.
This is especially true of habits that have become ingrained in our lifestyle.
If you didn’t try the exercise linked in the first few paragraphs, I highly recommend it. Knowing how much interest you are paying will change the way you view debt.
Another powerful exercise is to complete a debt analysis that lists all your creditors, debt balances, interest rates, minimum payments, and how long it will take you to pay off the debt.
Knowing and understanding the details of your debt situation is integral to this process.
How does your debt stack up? Another important factor for you to know and understand is how your family’s debt compares to other families in America.
These articles show the average household debt and average credit card debt in America. Both need to decrease for people to achieve financial security and be able to save for retirement. When you look at the average retirement savings in the US, you can see that as a nation, we have a long way to go.
Check your credit report. In addition to figuring out how your debt stacks up to others, it’s crucial to check your credit report for accuracy.
Not only will doing so let you identify any discrepancies on your credit report, but it will also allow you to see if your credit score needs work.
Fortunately, you can get a free copy of your credit report from the three credit reporting agencies – Experian, Equifax, and TransUnion – once per year through a website called AnnualCreditReport.com.
In addition, you should also try to get a copy, or at least an estimate, of your credit score.
Fortunately, you can get a free estimate of your credit score easily and quickly by signing up for an account with CreditSesame.com.
Understand your financial situation – start with a budget. The most important step you and your family can take at this point is understanding your financial situation.
Once you have completed the previous exercises I mentioned, you should now have a better grasp on where you stand financially. Now it is time to start up a budget.
My friend Lynnae wrote a great primer about how to build a budget for the first time, and you should absolutely read it. You can use many tools to help you make a budget, but if all you have is paper and a pencil, that will work fine.
You just need to do it.
Money Management Tip: Using money management or budgeting software can help you visualize this and make the job easier. You may find the following products helpful for your needs: Quicken, You Need a Budget, Mint.com, and other free online money management tools.
Commit to Eliminating Debt
More important than recognizing the need for change is actually following through with it.
This commitment can be broken down into two important steps:
- Stop using credit.
- Start paying down your loans.
Stop using credit. If you’re using credit cards and carrying credit card debt, cut up your cards, freeze them, lock them in a safety deposit box, and be willing to do whatever else it takes to stop spending money you don’t actually have.
It can also help to re-evaluate planned purchases.
For example, if you have a lot of consumer debt and were planning to use a loan for a major purchase, such as a new house or car, consider renting or buying an older model car with cash until you have eliminated your debt.
Get a balance transfer credit card. If you have a lot of debt at high-interest rates, getting a balance transfer credit card might also be ideal.
These cards let you score 0% APR on your balance for anywhere from 12 – 21 months. Some charge a balance transfer fee of 3-5 percent of your balance, but not all balance transfer cards charge this fee.
Either way, imagine how much money you could save if you could avoid paying interest on your credit card balances for nearly two years.
Keep up with your loans. Make sure you are paying at least the minimum payment on all loans so you can avoid being subjected to late fees, penalties, higher interest rates, and possibly a lower credit score.
The ultimate goal is to accelerate debt payments and pay as much as possible above the minimum payment.
While you’re getting started, however, it may be best to focus on being current on all loans.
Reduce your interest rates if you can. You may be able to contact your credit card companies and ask for a reduction in interest rates; some companies are willing to reduce interest rates provided you make on-time payments.
Another option is to do a 0% balance transfer, which we mentioned above.
This option allows you to transfer your credit card debt to a 0% interest credit card, avoiding interest payments for months in the process.
Consider this list of featured balance transfer cards and compare their offers before you sign up.
Cut your daily spending. If you’re spending money you don’t have on credit cards, chances are good you’re not living within your means. In order to get a better handle on your budget, it’s crucial to figure out exactly how much you earn each month and create a spending plan that allows you to spend less than that amount.
If your take-home pay is $3,000 per month, for example, you could keep your spending below $2,500 so you can set aside money for savings and emergencies.
To cut your daily spending, look for ways to reduce your monthly bills. Consider cutting cable television or downgrading your cell phone plan, for example.
If you’re spending a lot on food or dining out, you can also strive to cook most of your meals at home.
Get Support, and Get Your Family on Board!
Making big lifestyle changes can be difficult for one person. For this reason, getting an accountability partner or someone you can check in with if you’re not paying down debt as a family is a good idea. The moral support you receive from a trusted friend can go a long way toward keeping you on the right path.
On the flip side, paying down debt can be isolating and boring if you don’t have anyone to share the journey with.
On that same note, your family must be on board if you have one. What is difficult for one person can be impossible if someone is working against you, specifically a spouse or life partner.
Having your family working with you can make setting and keeping expectations easier, avoiding excessive spending, and making progress.
You can even use this as an opportunity to get your family involved by finding creative ways to cut expenses, earn a side income, or hold a garage sale to raise funds that can be used to pay off debt.
You can work together to achieve your joint goals with your family on your side and dedicated to the cause.
Establish an Emergency Fund
What does saving money have to do with paying off debt?
Everything.
An emergency fund is an essential part of the commitment to no longer using credit because it gives you cash to cover unexpected expenses. Using your emergency fund instead of credit cards or other loans will help you quickly get out of debt.
It is a good idea to keep your emergency fund in an online savings account where you can receive high-interest rates and maintain access to your money.
If you’re worried about how you’ll build up an emergency fund when you can barely keep up with your bills, keep in mind it gets easier with time.
If you’re able to cut your spending, you’ll find you have more cash to save and pay down debt every month, for example.
And, as you pay off old balances and work toward debt freedom, you’ll have even more cash to spend or save.
The first step you should take is to figure out how much you might be able to save every month as you ramp up your debt repayment efforts.
Maybe you can only save $50 or $100 per month at first, and that’s okay. If you could set aside even $100 per month for an entire year, you would have a small nest egg of $1,200 saved up after 12 months.
While that amount of cash may not save you in an emergency, it’s a good place to start and it’s certainly better than saving nothing.
In the meantime, you should also make sure you’re saving your money in the right place. Ideally, you’ll want to save your emergency fund in a savings account with a high interest rate.
However, you may also want to look for savings accounts that offer a signup bonus.
The more you can get your savings working for you, the better off you’ll be.
Accelerate Debt Payments
This is the step where we really start to gain ground on your debt elimination.
Paying extra on your loans can help you save hundreds or even thousands of dollars compared to making minimum payments.
In fact, the new credit card rules stipulate credit card companies must disclose how long it will take to pay off your loans with minimum payments and what your payments should be to pay off credit card debt in 3 years.
Highest Interest Rate vs. Lowest Balance. There are two schools of thought regarding which debt to pay first, the highest interest rates or the smallest balance.
- Paying extra on the debt with the highest interest rate will save you the most money in the long run, but it may take longer to notice a difference when you are making multiple payments each month.
- Making additional payments on the loan with the lowest balance gives a psychological boost because you eliminate a credit card loan or other debt more quickly using this method.
Both methods are successful, so use the method that you prefer.
Snowball your debt payments. The debt snowball is a debt reduction method popularized by Dave Ramsey. Simply stated: Pay extra on your loans and when you eliminate one loan, add the amount you were paying to the next loan on your list and repeat.
In this method, your payments “snowball” and you will eliminate your loans more quickly.
Pick up a side hustle. If you’re trying to pay down debt with a limited income, finding a way to earn more cash is one of the best moves you can make.
Fortunately, an array of new technologies have made it easier than ever to earn money in your spare time without a huge commitment.
If you have a nicer and newer car, for example, you could earn extra money driving for Uber or Lyft or delivering groceries with Instacart.
If you have plenty of spare time in the evenings but can’t really leave your home, on the other hand, it’s possible to earn several hundred dollars in extra cash each month by completing surveys online.
You can also make it a hobby to open bank accounts for sign-up bonuses. Many people can make an extra couple hundred dollars per month by opening new accounts.
Last, you could always look for a side gig walking dogs or doing basic yard work.
The best side hustle for you depends on your skill set and the amount of time you have to devote, but there are plenty of options.Advanced Debt Reduction Strategies
As you repay your loans and start tackling your balances, you will probably notice your credit score improves because you make regular, on-time payments, and your credit utilization decreases.
This is great news because it lets you know you are making positive changes to your financial health.
However, it may also help you as you seek to pay down debt faster.
As you push through the final phase of your debt payoff strategy, consider these tips, which can help you pay down debt at a lightning-fast speed.
Debt Snowball Method
Paying off multiple debts at once is a daunting task that can overwhelm you if you let it. Visible progress is often slow, making borrowers feel defeated when they see minimal results from their repayment efforts.
If you relate to the statements above, let us introduce you to the Debt Snowball.
With Dave Ramsey’s method of consumer debt elimination, you get what’s missing from other debt repayment strategies: tangible results, momentum, and motivation to follow through.
Intrigued yet? Below we’ve outlined how the debt snowball method works and provided you with the tools to use it.
Now let’s get the figurative [snow] ball rolling to see how Ramsey’s strategy can work for you.
How the Debt Snowball Works
The Debt Snowball, which is featured prominently in Dave Ramsey’s Financial Peace University, assumes you are using a balanced budget and are dedicated to getting out of debt.
Starting a Zero-Based Budget
You’ll need to work from a zero-based budget for the debt snowball method to succeed.
A zero-based budget is simple: Income-Expenses = Zero
In other words, every dollar you spend should match your income.
With a zero-based income, you know where all of your investments, purchases, and savings go monthly. It saves you time and avoids confusion, allowing you to focus on getting out of debt.
Here are Dave Ramsey’s simple steps to starting a zero-based budget:
- Start by writing down your monthly income. This amount should include everything you bring in.
Bonus tip: Ramsey suggests factoring in savings and giving here because you’re far less likely to give and save down the line. It’s all about priorities, people. - Then, write down your monthly expenses. This category includes everything from rent and utilities to phone bills, food, clothing, and spending money. Be specific!
- Next, include your seasonal expenses. We’re talking about vacations, holidays, and somewhat unforeseen costs like insurance premiums. Expect the unexpected!
- Now, pull in that equation above. Subtract your expense list from your income, and you should see a zero. If the subtraction didn’t give you $0, assign the leftover money somewhere.
Ramsey gives a wise piece of advice here:
If you don’t give it a name, it will be spent.
When every dollar has a job, you’ll have a clear idea of how much money you can put towards paying off your debt each month, letting you work quickly and effectively.
Steps to the Debt Snowball Method
Once your zero-based budget is squared away, you can start the rewarding process of paying off your debts with the debt snowball.
Here’s what you’ll need to do:
- List all your debts (excluding mortgage) from lowest balance to highest balance, regardless of interest rate. (Only consider interest rate when two balances are essentially the same, then list the highest interest rate first).
- Write down the balance and minimum payments.
- Make the minimum payment on each balance except the smallest balance, which you will pay extra on until it is eliminated. You will want to direct every available extra dollar you can find each month to this balance.
- Pay off lowest balance, then direct the funds you were paying on that balance to the next smallest balance.
- Repeat the process.
You can see how each minimum payment will be added to the previous payment, creating the snowball effect.
The Debt Snowball Paradox
Wait a minute? That doesn’t make sense! You aren’t paying off the highest interest rates first! It will take longer to repay your loans!
This is the most controversial feature of the debt snowball.
It’s true. All things being equal, you could pay down your debt faster by repaying your debt with the highest interest rates first.
But one of the main principles Dave Ramsey preaches is “personal finance is 20% head knowledge and 80% behavior.”
By paying off your lowest balances first, you get quick wins, which creates momentum and motivation.
If your highest interest rate is also your highest balance, you will see a minimal improvement each month on your largest bill and little to no improvements on the remaining bills.
Conversely, if you eliminate a couple smaller bills quickly, you will not only see those bills eliminated (which is motivating!), but you will see a larger dent being taken out of your remaining bills each month as your payment snowballs into larger and larger monthly payments.
The Debt Snowball in Practice
Let’s look at an example of the debt snowball at work.
Imagine you have the three following debts:
- $500 medical bill ($50 payment)
- $3,000 credit card debt ($65 payment)
- $10,000 student loan ($98 payment)
According to the debt snowball method, you’ll make the minimum payments on everything but the medical bill, since it’s your smallest.
Let’s say you’re being thrifty and pick up some overtime at work, combining to give you $500 extra a month to put towards repayment. You can now pay $550 monthly on the medical bill, comprised of the $50 payment and your extra $500. You’ll now have that debt paid off in a month.
What’s next? Take your $550 and put it towards your credit card debt.
With $615 (remember, you have $550 and the $65 minimum payment), you’ll pay it off in around four months.
2 debts down, 1 to go.
Now, you’re ready to conquer your biggest debt. You can put $713 a month toward your college debt, which means you’ll pay it off in a little over a year.
Because you prioritized and modified your money-managing behavior, you’ve knocked out over $10,000 of debt. It’s that simple.
Calculating Your Own Debt Snowball
That’s just one hypothetical situation. If you’d like to see how you can use the snowball method for your own debt-freeing purposes, try out our debt snowball calculator!
You can also create your own Debt Snowball by using paper and pencil, creating a spreadsheet with Excel or OpenOffice, using a free Excel Debt Snowball spreadsheet, or using a financial management software program like You Need a Budget, which helps you create a working zero-based budget and comes with a free debt snowball spreadsheet.
Deciding if the Debt Snowball Is for You
As with any finance-management method, there are pros and cons to the debt snowball method.
Below are some advantages and disadvantages to the debt snowball method, and some questions to ask yourself as you contemplate using this strategy.
Advantages of Using the Debt Snowball
- Psychological advantage of quick wins.
- Organized method for repaying your debts.
- Encouragement for budgeting and cutting expenses.
- Motivation to stay debt free.
Disadvantages of Using the Debt Snowball
- Not the most effective method mathematically.
- May cost more in interest rates in the long run.
The Deciding Factor
Ultimately, the decision of what debt-repayment strategy to use comes down to you and your tendencies.
Are you highly motivated by visible results and willing to put in some time, hard work, and savings to become debt-free? If so, the debt snowball method may be a solid choice.
Try out the resources above and look at our other articles on becoming debt free, and how paying off credit cards and debt affect your credit score to decide what works for you.
Advanced Debt Reduction Strategies
As you repay your loans and start tackling your balances, you will probably notice your credit score improves because you make regular, on-time payments, and your credit utilization decreases.
This is great news because it lets you know you are making positive changes to your financial health.
However, it may also help you as you seek to pay down debt faster.
As you push through the final phase of your debt payoff strategy, consider these tips, which can help you pay down debt at a lightning-fast speed.
Use a balance transfer credit card
If you have a good credit score, you can probably qualify for a 0% balance transfer card which allows you to transfer credit card debt to a 0% APR credit card.
This is an advanced debt reduction strategy because it requires opening a new credit card.
This should only be used if you are committed to getting out of debt and will not use the credit card for new purchases!
At this point, you may be wondering how a 0% APR card could make such a huge difference. Let’s look at an example:
Imagine you have $15,000 in credit card debt with an average APR of 18 percent.
If you made a minimum payment of 3 percent, or $450, it would take you 47 months (almost four years) to pay off your balance.
You would also make $5,950.81 in interest payments alone during this time!
Let’s imagine you transferred your balances to a balance transfer card offering 0% APR for 21 months.
First off, you would need to pay a balance transfer fee of $450, or 3 percent, up front. This brings your total balance to $15,450, which you could pay off without interest for 21 months in a row.
If you paid the same $450 per month, you would pay off $9,450 in debt over 21 months. At this point, you would have a remaining balance of $6,000, which you could pay off at a higher interest rate, or transfer to another 0% APR credit card.
If you were able to pay $735 per month for 21 months, on the other hand, you would become entirely debt-free without paying a dime in interest payments over 21 months.
Also, keep in mind not all balance transfers charge a balance transfer fee!
A handful of companies don’t charge this fee, although they typically only offer 0% APR for 15 months at most.
Either way, you should explore this list of featured balance transfer cards to find the right option for you and the amount of debt you have.
Sign up for debt consolidation
Another advanced debt reduction strategy is a do-it-yourself debt consolidation plan, which can reduce your interest rates and simplify repayment.
With debt consolidation, you usually consolidate all your debts in one place with either a balance transfer card or a personal loan.
With either option, having only one payment to make can simplify your finances and take a lot of stress out of the equation.
Consider debt settlement or a debt management plan
According to the Federal Trade Commission (FTC), debt settlement and debt management are additional options you can consider.
With debt settlement, a third-party company will call your creditors on your behalf and attempt to settle your debts for less than what you owe.
In the meantime, you’ll start saving up for debt settlement in a special savings account earmarked to pay off your settled debts.
With a debt management plan, you’ll work with a credit counselor to pay down debt faster.
Not only will they call your creditors and try to negotiate down your interest rates on your behalf, but they’ll even pay bills out of an account you set up with the credit counseling organization. These firms promise to save you money and help you avoid fees, but they aren’t risk-free.
The FTC notes that you should be aware of the risks of debt settlement and debt management plans before signing up.
All in all, getting out of debt will not only free up money for you on a monthly basis but not having the burden of debt collectors and high-interest rates will make your life much easier.
So, get started today on eliminating that burden in your life and live the life you were meant to live.
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James Mason says
Try the accelerated payment plan…start off with whatever that you can afford monthly that can be considered as “extra”. add this amount to your min. payment on the lowest balance card monthly; once its paid, take this payment along with that card’s minimum payment and pay the next card off. before you know it if you’re like me, you’ll be paying a couple thousand monthly on your larger balances, like that mortgage payment etc. its working for me and in about 5 years the only debt that I’ll have are the ones yhat you can never pay off, i.e. phone, cable, utilities, etc. good luck!
Andrea says
These are some good tips, but in order for me to be financially free one day I am going to have to pay down my debts the best way possible. Although I will try and set some money away for an emergency fund.
brokeprofessionals says
All good points. The issue of how to balance debt/savings is one of the most confounding issues in all of personal finance to me. It is not said often enough that people need to save up money if there job may be in jeopardy now or in the not so distant future. Once you pay off that debt, the monthly payments (in most cases) will stay the same, you will not be able to get it back, and you could have (if things went wrong) deferrred it anyway. (particularly with federal loans). Not that it is something you would want to do, but it is nice to consider all of your options.
K.C. says
I like to see aggressive debt reduction balanced with savings. Developing the savings habit is what keeps a person from taking on new debt. Making regular payments on debt and paying it on time will eventually pay off the debt provided no new debt is created. A healthy savings account is necessary to avoid taking on new debt.
Accelerated debt repayment is about saving interest on the debt. But interest is just the cost of time for the use of the money. As you mentioned, sometimes it makes sense to pay the interest in exchange for a little more time to pay off the debt. Especially, if it avoids the need to take on new debt.
krantcents says
If you can not pay it off, maybe a lower interest rate could be the answer.
Donny Gamble says
I’m not worried about paying down my debt right now because I rather invest that money into a business.
Kris says
Your third point is a good one. Ignoring your debt isn’t good, but if you really can’t pay it, look towards debt settlement or bankruptcy if needed. I used settlement and while I hated to do it, it helped tremendously. Part of me still feels guilty, but reducing the stress was well worth it.
Lonnie @ My Income Lab says
Right now my wife and I decided to put debt payments (it’s credit card debt) on hold because she is having a baby at the end of June. Maternity leave is unpaid and our cost of living is so high that we are aggressively building a savings for those few months we won’t have her income.
Ryan says
Lonnie, that is a great time to stop accelerated debt payments – it’s always good to have a little cash set aside in an emergency fund for expected and unexpected expenses!
Daddy Paul says
Good article. Debt can be a real monster which eats your lifestyle and well being. I say pay down on the highest interest first. Look at your debt as one large pile and attack the biggest expense first.
Kristine says
We’ve used the DOLP method, which means dead on last payment, to get out of debt. It was created by David Bach to organize your credit card bills in the most efficient and effective order to pay them down.
DOLP=credit card balance balance divided by minimum payment. When you use this method, it shows you which credit card you can pay off the fastest (the lowest DOLP number). You pay as much as you can on this credit card, and the minimum payment on the other cards. Once paid off, you move what you paid to credit card #1 to credit card #2 (the second lowest DOLP number).
MoneyEnergy says
I think the most important thing to do is create a plan to get out of debt and stop spending money you don’t have. Don’t waste your efforts trying to pay off your credit cards and other debt just to get back into debt again a year later. It’s like a diet this way. You need a long-term plan that will allow you to NEVER fall into debt again (i.e., beyond being able to pay your cards off in full each month), otherwise this is nearly wasted energy. So in order to lose weight, you first have to stop taking in more fat.
Ryan says
Agreed, Until Debt… If people aren’t on the same page, the battle is over before it starts. It can indeed be tough, but it is well worth it!
Until Debt do US part says
Great post. From my experience the most crucial element of success is getting everyone in the family on board. It is vitally important that the people around you, your friends and family, are fully behind you and understand what you are trying to do.
The last thing you need is for a conflict to develop between you and your partner as you try to cut back and repay your debts. It can be tough.
Kristen says
I quit using credit cards a little over two years ago. I don’t have one right now at all. I had a lot of debt that I had accumulated when I was younger and I was stuck in that vicious cycle of pay a little off, charge a little more, get nowhere reducing my debt.
It was really hard (and a little scary) at first to not have a credit card. But I finally started making progress paying off the bills and just making better spending choices the whole way around. It’s a relief to know that how much I owe is decreasing and I’m getting ahead instead of just treading water. I’m definitely celebrating when I make the final payment and owe no credit card debt.
Dividend Growth Investor says
It might also make sense to automate your debt repayment out of your paycheck. And if you ever get a raise, live as if you haven’t in order to avoid lifestyle inflation..
eric says
“Make sure everyone is on board”
This is CRITICAL when it comes to finances and marriage. For the first year of my marriage my wife and I had differing goals and understandings. It seemed like every time the budget allowed a few extra dollars my wife wanted to rush off and spend it instead of paying off a credit card, or making an extra payment. Great Bullet point, I can’t emphasize its importance enough!