If you’re struggling with debt and feeling overwhelmed by your financial situation, you’re not alone. Millions of people in the United States are dealing with debt – according to the Federal Reserve, U.S. consumer debt, which includes credit cards, auto loans, student loans and other forms of debt, totaled $16.9 trillion at the end of 2022.
The good news is that there are steps you can take to get out of debt and achieve financial freedom. Read on to learn practical strategies for getting out of debt and staying debt-free.
What is Debt?
Debt refers to an amount of money that one person or entity owes to another. When someone borrows money, they incur debt, and they are obligated to repay the amount borrowed, plus any interest or fees. In general, debt is considered a liability.
Debt can take many forms, including credit card balances, mortgages, car loans, student loans, personal loans, and more.
Credit card debt is one of the most common forms of consumer debt in the U.S., and can be difficult to pay off due to high interest rates.
Create a Budget
Before you employ a strategy to pay off debt, the first thing you need to do is create a budget. This will help you understand your income and expenses, and identify areas where you can cut back on spending so that you can allocate those funds to debt repayment.
Without a budget, it can be difficult to know how much money you have available to pay off your debts each month, and you may find yourself overspending and accumulating more debt.
I wrote an article on how to create a monthly budget, but here’s a quick overview of the steps:
- Calculate your income.
- Track your expenses.
- Categorize your expenses (i.e. fixed vs variable expenses).
- Set your goals.
- Make a plan.
- Monitor your budget.
4 Strategies for Paying Off Debt
Debt Snowball Method
This debt-repayment strategy involves paying off your debts in order from smallest to largest balance. To achieve this, you make minimum payments on all of your debts except for the smallest one, which you pay as much as you can towards it until it is paid off. Then, you move on to the next smallest debt, essentially building, or “snowballing,” your repayment toward the next balance. This cycle repeats until all of your debt is repaid.
Each balance payoff is a win. It’s a debt-repayment method that may not save you money on interest but could be a great motivator to keep paying off your debt.
Debt Avalanche Method
This debt-repayment strategy involves paying off your debts in order from highest to lowest interest rate. To achieve this, you make minimum payments on all of your debts except for the one with the highest interest rate, which you pay as much as you can towards until it is paid off. Then, you move on to the next debt with the highest interest rate, and repeat the process until all debts are paid off.
The name is relatively self-explanatory: This strategy involves transferring a debt balance from one account to another. Preferably, the debt moves to an account (or card) with a lower – or 0% – interest rate.
There are two important things to note if you go this route:
- Introductory 0% APR periods end after a certain period of time has lapsed, usually after 12 or 18 months.
- Typically, there are balance transfer fees, sometimes as high as 5% of the amount you transfer.
Depending on your circumstances, this strategy can save you money on interest rates, helping you pay off your debt more quickly.
Debt Consolidation Loan
A debt consolidation loan combines multiple unsecured debts – such as credit cards, medical bills and payday loans – into one fixed monthly payment.
This strategy is usually a good idea if the interest rate on the loan is lower than the combined rates on your existing debts. With this lower rate, you’ll save on interest and potentially pay off your debt faster. It will also help you manage your payments more efficiently.
Ultimately, the best strategy for paying off debt will depend on your individual circumstances, including the types and amounts of debt you have, your income and your financial goals. It’s important to choose a strategy that works for you and stay committed to it until you’re debt-free.
Related: “Good Debt” Versus “Bad Debt”
How to Avoid Debt Traps
Debt traps are financial situations that can lead to unmanageable levels of debt, making it difficult or impossible to pay off what you owe. Here are some of the most common debt traps, and tips for avoiding them.
High-Interest Credit Cards
High-interest credit cards can be a debt trap. A credit card’s interest rate is called its APR (annual percentage rate). With a credit card, APR most often comes into play when you carry a balance, but other transactions like cash advances and late payments are also subject to APRs, which might be higher than your regular rate.
To avoid this trap, pay off your credit card balance in full each month, or consider transferring the balance (as discussed above).
Payday loans can be tempting when you need cash quickly, but they often come with extremely high interest rates and fees.
Also called cash advance loans or check advance loans, a payday loan is a type of short-term borrowing where a lender will extend credit based on your income. Its principal is typically a portion of your next paycheck. These loans are considered predatory lending, as they have extremely high interest, don’t consider a borrower’s ability to repay, and have hidden provisions that charge borrowers added fees. As a result, they can create a debt trap.
To avoid this trap, try to build an emergency fund so you don’t have to rely on payday loans in the future.
Related: Establishing An Emergency Fund and 4 Places to Stash Your Savings
Medical debt can be a debt trap, especially if you don’t have health insurance or your insurance doesn’t cover all of your medical expenses.
To avoid this trap, make sure you have adequate health insurance coverage and consider setting up a payment plan with your healthcare provider if you are unable to pay the bill in full.
Medical debt is a leading cause of bankruptcy in the U.S. and affects millions of Americans each year. According to a recent study by the Kaiser Family Foundation, one in four Americans report having difficulty paying their medical bills.
Overspending on non-essential items can lead to credit card debt and other forms of consumer debt.
To avoid this trap, create a budget and stick to it. Only spend money on things you can afford, and avoid impulse purchases.
Co-signing a loan for a friend or family member can be risky, as you may be held responsible for paying off the debt if they are unable to do so.
To avoid this trap, consider alternatives to co-signing, such as lending money directly to the person in need, or helping them find other sources of financing.
Overall, it’s important to be aware of the risks associated with different types of debt and to make informed decisions about borrowing money.
By creating a solid financial plan and sticking to it, you can avoid debt traps and achieve financial stability. That’s what we’re here to help you do. We encourage you to set up a complimentary consultation with our team of financial advisors using the link below.