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Getting out of debt takes time and dedication, and the right way to do it depends on your situation. As you consider how much you owe and what you can reasonably do to pay it off, you'll have a better idea of the right course of action.
To help you get on the right track with managing your money, here are five steps to consider. You don't need to do all of them to be successful, and some may be unnecessary or impossible based on your situation, but the key is to research your options and find what works best for you.
1. Create a Budget
A budget can be an effective weapon against debt, and it's one of the easiest ways to tackle what you owe. The primary objective of a budget is to spend less than what you earn—in this case, so you can put that extra money toward paying off debt.
Start creating your budget by calculating your typical monthly income. If your income isn't consistent, take an average of the past three to six months, and make adjustments based on what you know about your situation. Then look at your expenses from the past few months to get an idea of what you usually spend each month.
To help calculate your expenses, first divide them into the two general buckets of fixed expenses and variable expenses. Fixed spending includes rent, utilities and car payments; variable spending includes eating out, entertainment and household items. Use this system to get the most accurate picture possible—and to figure out which areas you might be able to cut back on to free up extra money for debt payment.
Then make a plan for how you'll spend your money each month going forward, allocating some of the money you'd normally spend in discretionary areas to extra debt payment instead. During the month, keep track of your expenses to make sure you're sticking to your spending goals.
If your money situation is so tight that you don't have much discretionary spending, creating a budget may not make a big difference. But it will help you understand where your money is coming from and going to, and show you areas where you could stand to spend less.
2. Earn Some Extra Income
Earning extra cash can help you eliminate your debt faster. Even if you only have time in your schedule to make a little extra here and there, it can make a big difference in the long run. Here are a few ideas to get you started:
- Sell your extra stuff: If you have any items around the house that you no longer use, consider selling it through an online marketplace. Depending on what you're willing to part with, you may be able to earn a lot of money this way. Avoid selling anything you're likely to need to buy again soon.
- Work overtime: If your employer offers overtime hours and you have the ability to work extra, you can put all that extra cash directly toward your debt. Just remember that you'll still need to pay taxes and other deductions on your overtime earnings.
- Get a second job: Not everyone has the time to take a second job, especially if you have a family to take care of at home. But if you can, consider adding another job temporarily while you're working to eliminate your debt. You can also look at online job boards for odd jobs that don't require a set schedule.
- Start a side business: If you have a hobby or talent, consider starting a side business that allows you to earn money doing it. Maybe it's creating jewelry and selling it on Etsy, or freelancing as a writer, editor or graphic designer. If you have a marketable skill, starting a side business could give you more flexibility than a second job.
- Reduce your withholding: If you normally get a big tax refund each year, you could get more of that money into your paycheck if you have less taken out for taxes. Speak with your payroll manager about reducing your withholding so you'll have more take-home pay you can use to pay down debt. You won't get that big check come April, but you could end up paying less in interest and paying off your debt faster.
While these aren't the only ways to make extra money quickly, they can help you get an idea of what options are available based on your needs and available time.
3. Consider Debt Consolidation
Depending on the type of debt you have, you may be able to save money by consolidating it. While there are different methods you can use to consolidate debt, the main goal is to transfer high-interest debt to a low-interest loan or credit card, which can save you hundreds, if not thousands, of dollars in interest. Here are some potential options.
Balance Transfer Credit Card
If your credit is generally in good shape, you may be able to qualify for a balance transfer credit card. These cards usually offer an introductory 0% annual percentage rate (APR) promotion when you transfer a balance from another credit card or cards.
If you pay off the balance during the promotional period, which typically ranges from 12 to 21 months with major balance transfer cards, you won't pay any interest on the balance transferred. Once the promotion ends, however, you will be charged the card's regular APR on the remaining balance.
A couple of things to keep in mind:
- Many of these cards charge a balance transfer fee, which is typically 3% to 5% of the transfer amount. Some cards, however, opt not to assess this fee on introductory transfers.
- If transferring a balance causes you to max out the new card or get close to it, the high credit utilization rate, or amount of available credit you're using, could damage your credit score until you pay it down.
A balance transfer card can be great if you have a lot of credit card debt and can be disciplined enough to pay off the balance before the promotional period ends, or shortly thereafter. If you think you might be tempted to pay just the minimum on the new card, however, this probably isn't a good choice.
Debt Consolidation Loans
A debt consolidation loan is a personal loan used specifically to pay off other debts. You can consolidate many different loan types with a consolidation loan and, depending on your credit situation, you may be able to score a lower interest rate than what you're currently paying.
Unlike balance transfer credit cards, there is no 0% APR option. Consolidation loans have a set repayment term, which gives you more certainty about what you need to pay and when you'll be debt-free. If you choose to, you can also pay more than the set monthly amount. Also, there are no potential problems with having a high credit utilization because installment loans don't factor into that calculation.
If your credit isn't in good shape, though, you'll be hard-pressed to find a consolidation loan with a relatively low interest rate. If the rate is significantly higher than what you're paying, skip this option. But even if it's about the same, it may be better to have a loan with a set monthly payment than a credit card balance with no end in sight.
4. Look Into Debt Repayment Strategies
Regardless of what else you're doing to get out of debt, it's important to think about how to prioritize which debts to pay off first. For revolving debt such as credit cards and lines of credit, two main options to consider are the debt snowball method and the debt avalanche method:
- Debt snowball method: With this approach, you focus on paying off your debt with the lowest balance first while paying minimum payments on your other debts. Once it's gone, take the amount you were paying on it and apply it to the debt with the next-lowest balance, and so on.
- Debt avalanche method: This strategy uses the same process as the debt snowball method, but instead of focusing on your debts based on their balances, you target the debt with the highest interest rate first. Then once that's paid off, apply the money you were paying to the debt with the next-highest rate, and so on.
Which method works better? That depends on your goals and preferences. With the debt snowball method, the goal is to take wins early, which can make a big difference if you have several credit accounts. Paying off smaller debts quickly can help you stay motivated with your broader goal.
With the debt avalanche method, the goal is to save as much money as possible on interest. By eliminating higher interest debts first, you'll achieve that goal. That said, the difference in interest savings between the two approaches isn't always huge. Consider using an online calculator to see which is better for you.
5. Consider Getting Help With Your Debt
If your financial situation is dire and you don't see a way out with some of the other steps we've covered, it may be worth seeking help. Credit counseling agencies and debt settlement companies may be able to assist you. Here's how they work and what to know about each.
A credit counselor can help you by setting up a debt-management plan. With this plan, you make one monthly payment to the credit counseling agency, and it divvies it up into separate payments to your creditors.
One of the benefits of this option is that a credit counseling agency can negotiate lower interest rates with your creditors, which can potentially reduce how much you pay each month and save you money on interest.
Also, you're continuing to pay your bills on time, so you shouldn't expect a drop in your credit scores. However, you won't be able to apply for new credit while you're on the plan, which can take several years, depending on how much you owe. Also, you may be required to close your credit card accounts, so you don't accrue new debt while you're making payments, which can potentially hurt your credit score.
It's worth considering a debt-management plan if you're mostly current on payments, but your credit isn't good enough for debt consolidation.
The objective of this approach is to settle for less than what you owe. You may have a hard time doing this on your own, so you'll likely need to enlist the help of a debt-settlement company. Because of the damage it can do to your credit, debt settlement should be used only as a last resort.
Instead of creating a repayment plan as with a credit counselor, debt-settlement companies have you stop making payments to your creditors. Instead, you'll make a monthly payment into an account with the company, which it eventually uses to settle once the balance is high enough.
Debt settlement can potentially save you money in the short term because you're paying less than what you originally owed. But it can be much more expensive in the long run.
For starters, you may be on the hook to pay taxes on the amount of debt that was forgiven. Also, because you stopped making payments and paid less than the agreed-upon amount, debt settlement can wreck your credit, making it difficult to get approved for credit in the future. Even if you do, you can expect higher interest rates until your credit history recovers.
In general, debt settlement is worth considering only if you're already behind on payments, and you have no other options.
Consider Your Situation for the Right Approach
Just like there's no single way to get into debt, there's no one-size-fits-all solution for getting out of it. As you consider these and other potential steps, think about which approach is the best fit for your particular needs, goals and preferences. While that may end up being different from how others might suggest you do things, the important thing is that you make meaningful progress toward becoming debt-free.