Before diving into specific ways to pay off debt, it’s essential to create a solid financial foundation. The first step is to create a budget.
A budget helps you understand your income and expenses and how much you can allocate toward paying off debt.
Do you want to accelerate your debt repayment? Check out our Budget change workshop sessionor we have Debt repayment schedules!
Let’s look at a real-life example:
Meet Sarah: She’s a recent college graduate with $30,000 in student loans. To create a budget, Sarah begins by listing her monthly income, which is $3,000 from her job. After listing her basic expenses, like rent, utilities, and groceries, she realized she had $1,500 left over each month. Sarah decided to allocate $800 of this surplus to pay off her student loan.
It may be difficult at first to allocate all your extra money to debt, but trust me it will be worth it.
Debt collapse method
The debt avalanche method is a popular way to pay off debt quickly. With this strategy, you focus on paying off the debt with the highest interest rate first. Once you pay off that debt, you move on to the next debt with the highest interest rate.
Let’s see how Sarah applies this method:
Sarah has three student loans with interest rates of 6%, 4.5%, and 3%. It gives priority to the loan with an interest rate of 6%.
After making the minimum payments on the other loans, she directs her extra $800 toward the loan with the highest interest rate until it is paid off.
This method could save her a significant amount of money in interest payments over time.
The debt snowball method
Another popular strategy is the debt snowball method. In this approach, you focus on paying off the smallest debts first, regardless of the interest rate. Once you eliminate that debt, you move on to the next smaller debt.
Here’s how it works for Sarah:
Sarah has three student loans with balances of $10,000, $15,000, and $5,000. Instead of prioritizing the highest interest rate, I started with a $5,000 loan.
She has set aside an additional $800 for this loan and is quickly paying it off. The feeling of accomplishment that comes from getting rid of the smallest debt motivates her to tackle the larger debt.
This method can provide a psychological boost, even if it does not provide as much benefit as the debt avalanche method.
Debt consolidation
Debt consolidation is a strategy that involves combining multiple debts into one loan at a lower interest rate. This can simplify your monthly payments and potentially reduce the total interest paid.
Sarah considers this approach for her student loans:
Sarah qualified for a debt consolidation loan with an interest rate of 4%, which is lower than current student loan rates. By consolidating her $30,000 in student loans, she saves money on interest and simplifies her monthly payments.
This can be an effective strategy if you can secure a lower interest rate.
Increase income to accelerate debt repayment
While budgeting and smart debt payoff strategies are essential, increasing your income can significantly speed up the process.
Many people work part-time jobs, freelance work, or side gigs to generate extra income.
Sarah decided to work part-time as a freelance writer, earning an extra $500 a month.
This extra income is directed toward her student loans, helping her pay off debt more quickly.