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How to Pay Off Debt

5 min read

30 sec brief

While a big fat pay raise or bonus is welcome at any time, bringing in more income is not the only way to give a boost to your financial security. Paying off debt, especially high-interest credit card debt – is one of the best investments you can make.

While a big fat pay raise or bonus is welcome at any time, bringing in more income is not the only way to give a boost to your financial security. Paying off debt, especially high-interest credit card debt – is one of the best investments you can make.

The average interest rate on credit card debt these days is around 16%.  If you have an unpaid balance charging that much, paying off the balance ASAP is handing yourself a guaranteed 16% return. To be clear, there is no investment in the world that can deliver a 16% guaranteed return.

No credit card debt? Great. But imagine how good would it feel to make a bigger dent in paying back your student loans, or a car loan?

Here’s how to hatch a plan to pay off your debt.

Pay the minimum due on every debt. On time. You want to stay in the good graces of all your lenders, be it credit card issuers, car lenders, the mortgage company. And nothing makes your lenders happier than on time payments that cover the minimum payment due.

Another bonus is that paying your bills on time each month is also a key factor in your credit score. The sure-fire way to make sure you nail this step is to put all your recurring debt payments on an automatic-payment schedule from your bank checking account.

Unearth extra money to put toward repaying debt Okay, let’s tackle the financial elephant in the room:  finding the cash to add more to your debt payments. This is where a budget becomes priceless. Once you see all your spending broken down it becomes so much easier to find ways you can nip and tuck your way to free up more money for your debt repayment. Maybe there’s a big-ticket spending item you can get rid of, but it may be more practical to look across all your spending and aim for a similar goal. For instance, challenge yourself to see how many budget line-items you can reduce your monthly spending by at least 10%. Do that for a bunch of line items and you are going to have a nice extra pot of cash-flow to use to pay off your debts.

If you’re extra motivated, think about taking on a side gig and earmark 100% of your after-tax pay toward debt repayment.

Rank your debts from highest to lowest interest rate. The next step is to decide what debt (or debts) you want to focus on sending in more than the monthly required payment. The smartest financial strategy is to list your debts based on the interest rates you’re paying on all types of debts: credit card balances, auto loans, student loans, a mortgage. Highest to Lowest.

In terms of the biggest financial bang for the buck, the smart move is to focus on paying off/paying down your highest rate debt first. Speed-paying a 6% student loan doesn’t have the same payoff as working on getting rid of your credit card balance that is charging 16%.

But this is where human nature comes into play. Some people get more motivated when they are able to pay off smaller debts more quickly than if they focus on big debt that will take months or years to pay off. Or maybe you regret a certain debt and want to get out from that feeling. For instance, more than 25% of new car loans these days are for more than 72 months, which can mean you owe more than the current depreciated value of the car.

If you think you will gain some motivational mojo by paying off a particular debt, go for it. But if you’re looking for the smartest financial move: focus on the highest-rate debt first.

For credit card debt: Consider a balance transfer deal. If you have a strong credit score (typically a FICO credit score of at least 740) you may be able to qualify for a balance transfer deal that will not charge you any interest on the amount you transfer to the new card, for at least a year.

That’s a year or more where you can make some serious progress paying off the debt without the drag of being charged a high interest rate. Shop around for the best balance transfer [deals, and read the fine print. Some deals charge 3% or 4% of the transfer amount as a fee. That can still be worth it. And most cards extend the zero-rate deal only on the amount you transfer, all new charges you make on the card that you don’t pay off will be charged interest. The best strategy is to make the transfer and not use it for new purchases.

Make the Most of Paid-Off Debts. As you retire one debt, take whatever you were paying for that bill each month and now apply it to the next debt you want to wipe out. For instance, let’s say you pay off a car loan that was running you $400 a month. Take that $400 a month and apply it to another debt.

Peel Off Some New Income for Debt Repayment. Make a commitment to yourself that whenever you receive a raise, bonus, or tax refund you will use a set percentage of that extra income to pay off more debts.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

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