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. The right debt reduction plan, however, can help you start paying down your balances, stay on track with your budget, and work towards your future financial goals. Here are some options to get you started.
Tips to Build a Debt Reduction Plan
Prioritizing Expenses
A good first step is to look at everything you have coming into your bank account each month (income) and everything that is going out (spending). You can do this with pen and paper, or by leveraging an all-in-one budgeting app, such as SoFi.
Once you have a list of all of your monthly expenses, you can divide them into essential and nonessential expenses. Looking over your nonessential expenses, you may find easy places to cut back (such as streaming services you rarely watch or a membership to a gym you hardly ever use) to free up more funds for debt repayment. You may also need to cut back in other areas, such as meals out, clothing. and other discretionary purchases, at least temporarily.
A budgeting framework you might try is the 50-30-20 rule, which recommends putting 50% of your money toward needs (including minimum debt payments), 30% toward wants, and 20% toward savings and paying more than the minimum on debt payments.
Next, you can come up with a debt repayment strategy. Here are four popular approaches to knocking down debt. The debt 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 debt snowball method takes human behavior into consideration and focuses on maintaining motivation as a person pays off their debt.
The debt fireball method is a hybrid approach that combines aspects of the snowball and avalanche methods. Here’s a closer look at each strategy.
Debt Avalanche
The avalanche method puts the focus on interest rates rather than the balance that’s owed on each bill.
1. The first step is collecting all debt statements and determining the interest rate being charged on each debt.
2. Next, you’ll want to list all of those debts in order of interest rate, so the debt with highest interest is on top and the debt with the lowest interest rate is at the bottom of the list.
3. Now, you’ll want to focus on paying more than the minimum monthly payment on the debt that is first on the list, while continuing to make the minimum payments on all the others.
4. When the first debt is paid off, you can move on to paying more than the minimum on the second debt on your list. By eliminating debts based on interest rate, you can save money on interest.
Debt Snowball
The debt snowball method can be effective in getting a handle on debt by getting rid of debts on your list more quickly than the avalanche method. However, it can cost a bit more.
1. You’ll start by collecting debt statements and making a list of those debts, but instead of listing them in order of interest rate, organize them in order of size, with the smallest balance on top and the largest balance at the bottom of the list.
2. Next, you’ll want to put extra money towards the debt at the top of the list, while continuing to pay the minimum on all of the other debts.
3. Once you wipe away the first debt, you can start putting extra money towards the second debt on the list and, when that is one wiped out, move on to the third, and so on. This method provides early success and, as a result, can motivate you to keep going until you’ve wiped out all of your debts.
Debt Fireball
This strategy is a hybrid approach of the snowball and avalanche methods. It separates debt into two categories and can be helpful when blazing through costly “bad debt” quickly.
1. You’ll want to start by categorizing all debt as either “good” or “bad.” “Good” debt is debt that has the potential to increase your net worth, such as student loans, business loans, or mortgages. “Bad” debt, on the other hand, is normally considered to be debt incurred for a depreciating asset, like car loans and credit card debt. These debts also tend to have the highest interest rates.
2. Next, you can list bad debts from smallest to largest based on their outstanding balances.
3. Now, you’ll want to make the minimum monthly payment on all outstanding debts — on time, every month — then funnel any excess funds to the smallest of the bad debts. When that balance is paid in full, you can go on to the next-smallest on the bad-debt. This helps to keep the fireball momentum until all the bad debt is repaid.
4. Once the bad debt is paid off, you can simply keep paying off good debt on the normal schedule. In addition, you may want to apply everything that was being paid toward the bad debt towards a financial goal, such as saving for a house, paying off a mortgage, starting a business, or saving for retirement.
Using Personal Loans for Debt Reduction
Another debt payoff strategy you may want to consider is refinancing your debt. This involves taking out a personal loan, ideally with a lower rate than you are currently paying on your “bad” debts, and using it to pay off your balances.
Personal loans used for debt consolidation can help pull everything together for those who find it easier to keep up with just one monthly payment. A bonus is that because the interest rates for personal loans are typically lower than credit card interest rates, you can end up saving money.
Here’s a look at the process.
1. You’ll first want to gather all of your high-interest debt statements and total up the debts to be paid.
2. A good next step is to research your personal loan options, comparing rates, terms, and qualification requirements from different lenders, including traditional banks, online lenders, and credit unions. You may be able to “prequalify” for a personal loan for debt consolidation to get an idea of what rate you are likely to qualify for. This only requires a soft credit check and won’t impact your score.
3. Once you’ve found a lender you want to work with, you can apply for the debt consolidation loan. Once approved, you can use the loan to pay off your high-interest debts. Moving forward, you only make payments on the new loan.
The Takeaway
Having a debt reduction plan in place is key to getting rid of those financial handcuffs and being able to look forward to a successful financial future. To get started, you’ll want to assess where you currently stand, find ways to free up funds to put towards debt repayment, and choose a debt payoff method, such as the avalanche or snowball approach.
Another option is to get a debt consolidation loan. This can help simplify repayment and also help you save money on interest. If you’re curious about your options, SoFi could help. With a lower fixed interest rate on loan amounts from $5K to $100K, a SoFi debt consolidation loan could substantially lower how much you pay each month. Checking your rate won’t affect your credit score, and it takes just one minute.
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