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Creating a Debt Reduction Plan

April 17, 2019 · 7 minute read

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Creating a Debt Reduction Plan

When you’re worried about money and feel your options are limited, debt can feel like a pair of handcuffs. And if it feels like you can’t do what you want to do—which is to pay it all off and get yourself free—there’s the temptation to do nothing.

You can escape debt, of course, but unless you expect to win the lottery or inherit a large sum of money, it helps to have a solid plan for how you’ll do it.

Budgeting is boring. It’s also essential to staying on track. So start there. Look at your net income and your expenses—all the things you have to pay for every month. Then set priorities for how you’ll pay your long-term debts.

We’re going to get into some tips and tricks that might be helpful when crafting a debt reduction plan of your own. Of course, you ultimately have to do what’s right for your unique financial situation. And keep in mind that this isn’t advice—for that you’d have to consult a financial advisor. When you do make a plan to tackle debt, whether with an advisor or on your own armed with spreadsheets and a calculator, we hope this article gives you some inspiration.

Prioritizing Your Expenses

Before you start prioritizing your expenses, it is important to have a clear understanding of what you own and what you spend. You can do this manually or you can leverage an all-in-one app such as SoFi Relay. Now let’s dive into how you can prioritize your expenses.

Keeping a roof over your head is a number one priority for most people—especially if you own your home. Mortgage lenders are not very patient when it comes to getting their money. And failing to make your house payment can leave a big black mark on your credit record.

Make sure you’re current on your car loan and car insurance, especially if that’s your only way to get to work. Next, do your best with other big debts, such as student loans or large loans from friends and family. You definitely want to take care of these, but you may be able to get some relief or student loan forgiveness if you stay in contact with the lender and ask for help. You also may want to consider consolidating and refinancing your student loans into one manageable payment.

Finally, make a plan for credit card debt. Each month, you should do your best to make the monthly minimum payment. (Otherwise, your credit report can quickly reflect any lack of payment .) And to tackle the outstanding balances you’re carrying, it may be time to work out a new payment plan so you can get out from under your credit card debt.

Once you know where you stand, you can move forward with a personal debt reduction plan to deal with all those long-term bills that have you tied up with worry.

There are four popular approaches to knocking down debt: The “avalanche” method is probably best suited to those who are analytical, disciplined, and want to pay off their debt in the most efficient manner based solely on the math.

The “snowball” method takes human behavior into consideration and focuses on maintaining motivation as you pay off your debt. The “fireball” method is a hybrid approach that combines the best of the “snowball” and “avalanche” approaches.

And a personal loan may be an option for those who have a solid financial history or whose credit score has improved since they first signed up for their high-interest loans and credit cards.

Here’s how each strategy typically works:

Debt Avalanche

This method puts the focus on interest rates rather than the balance that’s owed on each bill.

  1. Collect all your statements and determine the interest rate you’re being charged for each debt.

  2. Make a list of all those bills. Don’t pay attention to the amount you owe on each statement. Instead, put the bill with the highest interest rate at the top, then proceed on down until you get to the bill with the lowest interest rate.

  3. Keep in mind any fees, prepayment penalties, or tax strategies that could make one debt more or less expensive than the others. Also, if you’ve gone the balance-transfer credit card route to save money, be sure to re-prioritize your list once the introductory rate runs out and a higher rate kicks in.

  4. Continue to pay the minimum on each bill on time every month. But pay extra (as much as your budget allows) toward the bill at the top of your list.

  5. When you pay off that bill, move on to the next debt on the list and start paying extra there. You’ll save money as you eliminate each of those high-interest loans and credit cards, which can allow you to pay off all your bills sooner.

Debt Snowball

This approach can help you get a handle on your debt by slowly reducing the number of bills you have to deal with each month.

  1. Collect your statements and make a list of your debts, organizing them from the smallest amount to the largest.

  2. Continue to pay the minimum on time every month, but pay extra—as much as you can—toward the smallest bill on your list. (If possible, completely pay off the balance on that very first bill. It can give you some sweet momentum to get started.)

  3. As with the avalanche method above, pay attention to fees, penalties, and other circumstances when determining who gets paid first.

  4. Move on to the next debt on your list, and so on. It will probably take a little longer to pay off each debt as you go, but keep the faith. And stay motivated by keeping the list handy, with a red line through each paid-off debt.

  5. Keep going until all your debts are paid. Don’t use the credit cards you’ve paid off. And make it a goal to set up an emergency fund so that if you have an unexpected expense—a medical bill or car repair, for example—it doesn’t knock you off track.

Debt Fireball

This strategy is a hybrid approach of the Snowball and Avalanche methods. It separates your debt into two categories and can help you blaze through costly “bad debt” faster. Check out how this might work for some:

  1. Categorize all debt as either “good” or “bad.” (“Good” debt is generally in the form of things that have potential to increase your net worth like: student loans, business loans, mortgages etc. “Bad” debt, on the other hand, is normally considered to be debt incurred for a depreciating asset, like car loans and credit card debt.) As you are developing this list, identify all your debt with an interest rate of 7% or higher. This is likely the “bad” debt you might want to focus on first.

  2. List your bad debts from smallest to largest based on their outstanding balances.

  3. Make the minimum monthly payment on all outstanding debts, then funnel any excess funds to the smallest of your bad debts.

  4. When that balance is paid in full, go on to the next smallest on the bad-debt list. Torch those balances until all your bad debt is repaid.

  5. When that’s done, keep paying off your debt on the normal schedule while investing in your future. Apply everything you used to pay toward your bad debt to a financial goal, such as saving for a house, starting a business, saving for retirement, etc.

Personal Loan

With a personal loan, you may be able to consolidate your debts at a lower interest rate and pay them off in less time than you expected.

  1. Gather your statements and total up the debts you want to pay off.

  2. Check your credit report so you get an idea what interest rate you could qualify for (most lenders will offer a range). Make sure the information on your credit reports is accurate.

  3. Look at a variety of lenders to find the best interest rates available. Keep the length of your loan in mind, as well. The goal is to find a manageable payment but also to get your debt load paid off as quickly as possible.
Apply for the loan that best suits your needs. Consider other member benefits or other perks that lenders may offer, such as a hardship deferral or a discount on a future loan.

  4. Pay off your old debts with the personal loan, and stay current with your new loan payments. Stick to a budget that helps keep you from making the same spending mistakes. No more winging it, racking up credit card debt, or living paycheck to paycheck.

  5. Personal loans for debt consolidation are growing in popularity—partly because with just one monthly payment, they’re simply easier to keep tabs on. If you aren’t a good list maker or record keeper, it can help pull everything together for you.

But the bonus is that because the interest rates for personal loans are typically lower than the rates offered by credit card companies, you’ll likely end up paying less than you would have if you just kept plugging away at those individual debts. For those who qualify for a good rate, a personal loan can make other debt payoff methods feel obsolete.

With a personal loan from SoFi, you can consolidate your debts and get them paid off in a way that works better for your income, budget, and timeline.

Whatever payoff method you choose, the point is to do something. Having a debt reduction plan in place is key to getting rid of those handcuffs and moving on in your financial life. By planning ahead, saving for specific goals and keeping to a budget, you’ll help minimize your dependence on credit cards or high-interest loans in the future.

Ready to tackle your debt head on? A personal loan from SoFi can help you to consolidate your debt into one easy to manage monthly payment.


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