A Step-by-Step Guide to Getting Out of Debt

Tense couple reading bills together
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Debt will keep you from reaching your financial goals, like saving for retirement or buying a home. It can be a source of stress and grief, causing you to constantly worry about your finances and regret the limits debt has placed on your life.

Fortunately, debt isn't a life sentence. You can (and should) make getting out of debt a priority. Follow these seven steps to take control of your finances and pay off your debt for good.

1. Understand the Type of Debt You Have

Getting out of debt—and staying out—requires that you change the habits or circumstances that led you to debt in the first place.

Understanding the type of debt you have, and how it happened, can help you create a plan for paying it off and make it less likely that you will fall back into debt in the future.

If you have debt that you don't know how to manage, consider talking to a credit counselor. Credit counseling agencies are usually nonprofit organizations such as the Financial Counseling Association of America or the National Foundation for Credit Counseling. They are staffed with trained agents who can help you with:

  • Understanding your debt
  • Tracking your spending
  • Creating a budget
  • Developing a debt repayment plan

Debt Due to Loans

Taking out loans happens naturally at certain stages of life. You may take out a loan to open a small business, buy a house with a mortgage, need an auto loan to purchase a new car, or take on student loans to fund your education.

These debts are not inherently bad, and they often come with manageable interest rates. However, they can create a strain on your finances when you are unable to make the required payments. They can eat up too much of your income, preventing you from covering your living expenses or saving money.

When that happens, you may find yourself taking on other debt, either in the form of credit card debt or personal loans, to make up the difference.

Debt Due to Circumstance

Sometimes debt accumulates due to circumstances outside your control. Many people have medical debt stemming from unexpected illnesses or injuries. You may have debt due to divorce. Or you may have become unemployed and had to take on credit card debt or take out personal loans or payday loans.

These debts can be crushing because they come with high interest rates. Often, you are forced to take them on when your financial circumstances were already strained. And as you attempt to pay them off, they can eat into your income and require you to take on more debt, creating a debt spiral that feels impossible to escape.

In many instances, such as when medical bills go to a collection agency, you may not even be aware that the debt exists until a collection agent calls you at home to report that you have unpaid bills.

Debt Due to Spending

Thoughtless or reckless spending can create its own debt, usually in the form of high-interest credit card debt. Living beyond your means, such as taking out a mortgage your income cannot support or buying a car you cannot afford with an auto loan, can also create debt due to spending.

Once you accumulate debt due to overspending, you end up paying far more in interest and penalties than the actual value of what you purchased. This can tie up your income, requiring you to take on even more debt. Living beyond your means can even cause you to default on payments or end up declaring bankruptcy.

2. Take Control of Your Spending

Whether or not careless spending habits contributed to your situation, you will find it easier to start to pay off your debt if you keep close control of your spending and finances.

Take time to compare your monthly income with your expenses. Divide your spending into mandatory expenses, or needs, and discretionary expenses, or wants.

Mandatory expenses include things like:

  • Rent or mortgage payments
  • Utilities
  • Food
  • Transportation to/from work
  • Health insurance
  • Child support
  • Prescriptions
  • Childcare

Discretionary expenses include things like:

  • Cable TV
  • Gym memberships
  • Eating out
  • Clothing
  • Entertainment
  • Home decor
  • Personal grooming

In order to start paying off your debt, your monthly expenses will need to be significantly lower than your monthly income. You may be able to achieve this just by reducing your discretionary spending.

Pay your bills on time to save money. Late payments usually trigger fees or service charges that can make it harder to reduce your spending. Where possible, automate your payments to come from your checking account.

If that's not enough, however, you may need to take further control of your spending by lowering your mandatory expenses as well. You can use tactics like:

  • Downsizing if you rent your home or negotiating your rent
  • Renting out a room or floor if you own your home
  • Choosing a cheaper cell phone plan
  • Splitting internet access with a neighbor
  • Choosing a less expensive health insurance plan
  • Looking for ways to cook cheaply, such as eliminating meat from your diet
  • Using public transit instead of your car

You can also look for ways to increase your income, even temporarily, such as:

  • Taking on a second job
  • Doing occasional gig work
  • Putting all your credit card rewards toward cash payments instead of points
  • Insisting that money you are owed, such as child support or alimony, be paid
  • Selling household items, jewelry, or clothing

Local pawnshops make it easy to sell your items for cash. However, you will likely make more money if you sell directly to other consumers through Craigslist, eBay, Etsy, or your local consignment shop.

Once you have reduced your spending as much as possible, create a budget. This will prevent you from accidentally overspending. You want to make sure your expenses stay below your income; otherwise, you will end up owing more money in the form of credit card interest or overdraft fees.

Reducing your spending as much as possible, and taking control of your finances with a budget, will allow you to put all almost your extra money toward paying off your debt.

3. Figure Out How Much Debt You Have

If you have more that one type of debt, it can be easy to lose track of how much you owe and how much you are paying in interest every month. But you cannot begin to pay off your debt until you know what those values are.

Make a list of all your debts, how much you currently owe, and the interest rate being charged. Use recent billing statements, canceled checks or bank statements, and your credit report to get a complete list of everyone you owe and the amount you owe. Be sure to include the minimum payment required for each account. This is the smallest amount that you can afford to pay on your debt every month.

Including the interest rate associated with each account will show you not only how much you currently owe but also which debts are the most expensive. High-interest debts, like credit card debt or payday loans, can cost you many times the value of the loan itself because of the amount of interest that is added on every month.

4. Decide How Much You Can Afford to Pay

If you pay only the minimum every month, it can take years or even decades to finally pay off your debt. To eliminate your debt much faster, you’ll have to send more than the minimum payment to at least one of your accounts each month.

Use your monthly budget to decide how much you can spend on debt repayment each month. Subtract your expenses from your income, including any irregular or periodic expenses that may pop up during the month. What's left over after you've covered all your necessary expenses is the amount you can spend on your debt. Use this amount in your debt plan.

If your income varies per month, base your amounts for your budget and debt repayment on the lowest income you expect to have. If you have extra some months, you can use that money for debt repayment. The more money you can put toward your debt, the faster you can have it paid off.

Remember, you need to make the minimum payment on each debt every month, so however much you have in your budget for debt repayment, you will first need to subtract every minimum repayment from that value. Whatever is leftover, you can put towards truly paying off your debt.

For Example

  • Your monthly income is $4000 and your monthly expenses are $3500.
  • $4000 - $3500 = $500 for total debt repayment
  • You have three debts with minimum payments of $50, $75, and $100 per month.
  • $500 - $50 - $75 - $100 = $275 for accelerated debt repayment

5. Put Together a Plan

Decide in what order you are going to pay off your debt. You can decide to prioritize based on the interest rate, balance, or some other criteria that you choose. You can also use additional debt management strategies to reduce your monthly payments or consolidate your debt.

Whatever debt repayment strategy you choose, stick to your plan and send payments on time every month to avoid additional fees and interest charges. Eliminating your debt completely can take months or years depending on the amount of debt you have and the payments you make. Consistency with your payments is a necessary part of getting out of debt.

Debts that have gone into collection can do the most damage to your credit score, and repeated calls from collection agencies can damage your overall emotional well-being and stability. If you have debts that have gone to collection agencies, these are the ones you should repay first.

The Snowball Method

Using the Snowball Method, you pay off your debts from the smallest to the largest.

The "Snowball Method" is a term coined by Dave Ramsey. The name refers to the strategy of starting with something small and building it into something bigger, the way a snowball is made.

Make the minimum payment on every debt, then put any extra funds you have toward the debt with the smallest balance. This will be the one you can pay off most quickly, allowing you to see immediate progress on your debt repayment.

Once this debt is paid off, move onto the next smallest debt on your list, while continuing to make the minimum payment on everything else. You will have more money to put toward paying off this debt because you now have fewer minimum payments to make every month.

Continue until you have paid off all your debts.

Debt Stacking

This strategy focuses on prioritizing debt by interest rates.

The higher the interest rate, the more a debt will cost you over time. Eliminating the debt with the highest interest rate will allow you to save the most money in the long run.

Debt stacking is sometimes called the Avalanche Method to contrast it to the Snowball Method.

Make the minimum payment on every debt, then put any extra funds you have toward the debt with the highest interest rate. Once this debt is paid off, move onto the next highest interest rate, while continuing to make the minimum payment on everything else. As with the Snowball Method, you will be able to put more money toward paying off each subsequent debt because you have one fewer minimum payment to make every month.

Student Loan Adjustments

If you have student loans, you may be able to have the amount you owe adjusted based on your income or financial situation, particularly if you have loans from the federal government. This can help you lower your monthly payments while you focus on paying off other debts or improving your financial situation.

Once you have eliminated your other debts, you can start to make higher payments on your student loans.

Debt Consolidation

If you are having trouble managing too many debts, you can consolidate them into a single debt. This is a loan that covers the cost of your current debts, leaving you with only a single payment every month.

Consolidation does not eliminate your debt, but it does simplify it. However, it can be accompanied by high fees and variable interest rates that could end up being more expensive than what you were previously paying. Before consolidating your debt, it is best to speak to a credit counselor to decide whether this is the best course for your financial situation.

If you do decide to use a debt consolidation loan, be careful not to take out additional loans or open new credit cards before it is eliminated. Otherwise, you will end up with additional debt that you cannot repay.

6. Build an Emergency Fund

As you work toward paying off your debt, you should also start to put money away in and an emergency fund as well. Building an emergency fund gives you more flexibility to handle surprise expenses, which makes it less likely that you will go into debt again in the future.

Even a few hundred dollars can help if you need to have car repairs done or pay a doctor's bill. This will reduce the likelihood that you have to take out a payday loan or additional credit card debt when unexpected expenses arise.

Use a high-interest savings account or a money market account so your emergency funds earn interest but remain accessible at all times.

7. Don't Create More Debt

Creating debt while you're trying to pay off debt will hurt your progress and create more interest that you cannot pay off. While you are attempting to pay off your current debt, avoid using your credit cards, opening new credit accounts, or taking out new loans.

You may decide to close your credit card accounts entirely if you don't think you'll be able to resist using them. However, you can also keep a credit card on hand for emergencies but not use it for everyday spending.

You can freeze your credit cards to prevent yourself from using them if you don't want to close the accounts completely. Place your credit cards in a bowl or plastic bag full of water, then put them in the freezer. You'll have to put in a lot of effort to get them out of the ice, which will give you time to rethink using credit before you're out of debt.

You can estimate the time it will take you to become debt-free by using a debt repayment calculator. Some let you enter a specific monthly payment or a debt-free deadline to customize your repayment plan.

Note that your debt repayment time may fluctuate depending on the amount you're paying toward your debt and whether you create additional debt. Revisit the debt repayment calculator once or twice a year to see how you're progressing toward your debt-free timeline.

8. Bounceback From Setbacks

It may not be smooth sailing on your path to debt freedom.

A financial emergency could require you to cut back on your increased payment for a few months. You may find yourself needing to use credit cards or take out a personal loan to handle an unexpected situation.

When that happens, recalculate your budget and pick back up with your payments as quickly as possible. Overcome discouragement and keep your debt repayment on track.

Creating debt milestones may help you stay focused and encouraged while you pay off your debt. By celebrating the small successes, like paying off your first loan or eliminating 10% of your total debt, you can make it easier to stay motivated toward eliminating your debt completely.

Article Sources

  1. Consumer Financial Protection Bureau. "What Is Credit Counseling?" Accessed May 11, 2020.

  2. Consumer Financial Protection Bureau. "CFPB Spotlights Concerns with Medical Debt Collection and Reporting." Accessed May 11, 2020.

  3. Consumer Financial Protection Bureau. "How to Reduce Your Debt." Accessed May 11, 2020.

  4. Federal Student Aid. "Choose the Federal Student Loan Repayment Plan That’s Best for You." Accessed May 11, 2020.

  5. Consumer Financial Protection Bureau. "What Do I Need to Know If I’m Thinking About Consolidating My Credit Card Debt?" Accessed May 11, 2020.