When considering the path to financial independence, one of the first steps is addressing any debts your family may have. Many debts have high interest rates, much higher than average market returns, so paying off debts is a great use of allocating funds before investing for retirement. As a general rule, the recommendation is usually to pay off any debts bearing an interest rate higher than 4%. Your risk tolerance may be higher or lower, but I usually stick to this rule. As it stands, we currently have a loan for my vehicle at 1.74%; anything higher than 3%, I would likely pay off.
The average American household has $7,529 in credit card debt. However, this includes those who don’t carry a balance or don’t have debt at all. So when accounting for only families in debt, the average household has $16,140 in credit card debt. (Source)
While your family may not have debt like those numbers, or may have more debt than that, it doesn’t mean you can’t tackle it. Eric and I paid off $7,000 in credit card debt in less than a year by eating at home, creating extra income, and selling things around our home.
There are some great inspiring resources out there for how to pay off debt. I love Dave Ramsey’s Baby Steps and his “gazelle intensity.” Mr. Money Mustache has a post titled “Your Debt Is an Emergency,” and it is a good motivator to realize why you need to get out of debt. As for me, I’m just going to share some strategies I’ve heard and read and collected and tried over the years.
Step One: Get it all together
You can’t fight what you don’t know, or whatever the phrase is supposed to be. Whether it is through pen and paper, an Excel spreadsheet, YNAB, or cave drawings, figure out all of your creditors and how much you owe them. I would suggest an Excel spreadsheet titling each creditor, the balance, the minimum payment, and the interest rate.
Step Two: Make a plan, set a goal
You didn’t accumulate $5,000 of credit card debt overnight, it won’t go away overnight. If you really did accumulate $5,000 overnight, it probably still won’t go away overnight.
Take your Excel spreadsheet or notebook from Step One, and rank your cards in the order you want to pay them off in.
There are two mindsets on paying off debt: the Snowball method, as advocated by Dave Ramsey, and the Avalanche method, as advocated by mathematicians. Either method suggest paying the minimum payment on all of your cards except the one you are currently focusing on paying off, and moving all of the monthly payment for that card to the next card after the first is paid off. The snowball method suggests paying off the balances from smallest to largest in order to generate psychological wins. The avalanche method suggests paying off debts from highest interest rate to lowest interest rate in order to pay less in interest.
I suggest a mix of both methods. The psychological aspects of small wins cannot be dismissed. If you have one debt with a balance below $500, I would choose that one first. If you have multiple under $500, choose the one with the highest interest rate first. Target that aggressively, and when you knock it out, celebrate your small win, and use your momentum to target your highest interest rate card, no matter the balance. Plus, this will give you that extra $20+ per month that was your minimum payment toward the small card to put toward the other card. It’s only a little more, but it can help it go so much faster. (On a $4,000 card with an 18% interest rate and an $80 minimum payment, paying $100 per month instead would save you $1208.76 in interest over the term of the payoff.)
If you like number information like above, one of my favourite resources of all time is unbury.us. It allows you to add your debts, their interest rates, and compare the avalanche and snowball methods. I find it excellently motivating to see the difference an extra $5 or $10 per month can really change.
Using unbury.us or a spreadsheet, you can find a realistic timeline to set as a goal. When calculating your income you can allocate to debt payoff, make sure to only use income you can reliably receive each month. If you set your goals based on the idea that you would have 10 hours of overtime every week, even though you know that only happens for 2 months a year, you will be sorely disappointed. Set a goal that is a challenge but is achievable. You can set monthly, quarterly, yearly goals, or all three.
Step Three: Stick with it
When you set your goals, remember not to be too hard on yourself. You’re in this for the long haul. Don’t say you’ll never go out to eat ever again, but remember that every $40 meal at Olive Garden could pay off your credit card much sooner. So live a little while you’re paying off the debt, but remember that you’re working toward a goal in the long term. You can do it!
There are also other suggestions that many have had success with to pay off their debts.
Debt Consolidation Loans
Debt consolidation loans are a great resource to pool all of your debt into one loan, potentially with a lower interest rate than your credit cards or other loans (if the rate comes back higher than some of your debts, you may be able to choose to leave that debt out of the loan). It will give you an exact payoff amount each month and a timeline when it will be paid off. With most institutions, you can pay the loan off early and have no additional fees. A con to this is that you may go from having 6 cards with balances from $400 to $2,000 to one loan with a $6,000 balance, and you lose the psychological benefit of little wins. However, the largest con to a debt consolidation loan can occur if you don’t have a plan to stick to a budget. If you consolidate all of your credit cards and charge them all back up 3 months later, it didn’t help you at all.
Balance Transfers
Similar to above, you may be able to transfer all of your credit cards to a new card through a balance transfer at a lower interest rate for a defined period of time. It is important to make sure that you don’t charge your cards up again, as listed above. Also, consider that the new card may have a balance transfer fee, and may have interest charges from the beginning if you don’t pay off the balance in the specified period of time. Any charges on the new card will usually also accrue interest until the entire balance, including the balance transfer, is paid off. You may also lose the promotional interest rate if you don’t make payments on time. If you know you have the willpower to stick with it in the long term and make payments on time, a balance transfer may save you thousands in interest, but it may just be a band-aid on a cut that needs stitches.
Hardship Programs
If a lot of your finance problems are coming from a job loss, a move, or any other hardships that were unexpected, it may be worth it to contact your creditors and ask about hardship programs. I’ve found I’ve had more success when using that term specifically. Years ago, one creditor closed my card while I paid it off, and lowered my interest rate from 22% to 8% as long as I set up automatic payments. Not all creditors will offer these programs, and if you don’t have an actual hardship, it may not be available to you, but it is definitely worth asking about.
Bankruptcy
This should be an absolute last resort. In 2012, 30% of bankruptcy filers had filed before in the previous 8 years. (Source) What does this mean? For many, it’s more of a band-aid than anything. If you use it to wipe the slate clean, but never learned how to clean it yourself, it’s going to end up dirty again. Of course, there are other scenarios, such as medical debt, but for credit card debt and consumer purchases, it is best to have a plan of action to get out of debt yourself and prevent it from happening again.
You will get through this! A little at a time. A lot of snowflakes make a blizzard, and you can totally demolish your debt with a good plan and some dedication.
