This article will go over the steps you need to take to get rid of that weight around your neck – your debts. Hopefully answering the question, once you’ve figured out how much money you owe, how do you pay your debts off?
I’ll be mainly concentrating on credit card debts, but all debts are included.
Getting out of debt is the third step in my five steps to wealth. The first being starting a budget, the second gaining control over your spending, the third getting out of debt, the fourth saving, and the fifth investing.
So let’s get started.
It’s Time to Get Real & Determine How Much Debt You Have
The first step is to actually acknowledge how much debt you actually have. You can’t be an ostrich with your head in the sand if you are going to change things. You need to get real.
But since you’re on this page, I’m guessing you’ve already committed to that and are willing to follow whatever steps it’ll take to pay your debt off.
“Face your fear and work out how much debt you have.”
Decide what method you want to record all your debts into.
I personally prefer a spreadsheet because I like to make columns and watch the numbers decrease over time. Plus you can sort columns by highest interest rate, or lowest balance. You can also make graphs of your progress with a spreadsheet program, which I’ll admit is unnecessary, but they look pretty and if you’re a visual person, can sometimes help to motivate you.
You can also use a paper planner or journal if you like to write things down. And there are phone apps that will help you budget and pay off debts as well.
Use whichever method you prefer.
Write Down all of Your Debts
The next step is to make a list of every debt you have. Whether that’s credit cards, personal loans, car loans, your mortgage (if you have one), etc. Everything that you owe money to.
You might wonder why I’m including your mortgage in this.
While your mortgage isn’t the top priority when it comes to paying down what you owe since the interest rate is usually low (and the amount borrowed huge), it’s still a good idea to keep a record of how it’s progressing. And there are plenty of people that want to tackle their mortgage once the rest of their debts are paid off.
You want to also include in this section, how much money you owe for each of those debts, what the minimum payment is, and what the interest rate is.
You should be able to find out the interest rate and minimum payment on your statements. Note that your minimum payment will change as your debt gets smaller.
Once you’ve done that, total it up to find out your debt figure.
Phew. The scariest part is over. Now you can fix this.
Displaying your debt total somewhere visual
There are some people who feel motivated to display how much they owe somewhere where they can see it every day because it keeps it at the forefront of their focus.
While it’s true that writing out your goals and putting them somewhere visual, like a vision board, will give you a higher chance of achieving those goals, I’m not sure I’d want how much I owe on display where anyone might see it.
If the visual reminder does motivate you, then I suggest instead of a vision board, that you place your debt figure somewhere private where you could still see it every day, but no-one else could pry.
Personally, I think it’s fine just to keep it in your spreadsheet or journal and keep that private.
Now That You Know What You Owe, How Do You Pay It Off?
There are two general strategies to pay off your debts that most people choose.
The first is the method of paying the debt with the highest interest rate first, and once that’s paid off, moving onto the next highest interest rate and so on.
The reasoning behind this is that by eliminating the highest interest rates first, over time you’ll be paying less interest to the banks and be able to get ahead faster.
The second strategy is instead of paying the highest interest rates, you pay the lowest balance debts first. This strategy is often called the Debt Snowball Method made popular by finance author, Dave Ramsey.
The reason for this method is that with each debt being crossed off your list, it provides motivation to keep going and it’s quicker to pay off lower balances than higher ones, providing a sense of accomplishment.
You will pay slightly more in interest with this second method, but it’s more motivating and once you’ve paid off the first debt, it can improve confidence levels that it’s possible to be debt free one day.
So, out of the two methods, I prefer the second. Having a lot of debt can be overwhelming so by paying off the smallest balances first, and getting it off your list, it can provide confidence over your finances that you can’t put a price on (yeah, I meant that pun).
How Much Money Do You Have to Pay Off Your Debts?
How much money you have that you can use to pay off your debts is going to be different for everyone based on what your income and expenses are.
The only way to know is to have a budget. Budget’s don’t have to be complicated, they are just a way to keep track of your finances so that you can gain control over your money.
Record your income and expenses over the course of one month to get a rough idea of where you’re money is going. That way you’ll be able to see at a glance where you can cut back and make changes.
The more changes you can make to save spending, the more you’ll have to pay off your bills.
I suggest paying the most money you can on your debts. But that doesn’t mean going without anything else. All budgets need some discretionary money for small purchases. If you tighten things too much it can suck all the joy out of life.
Having said that, you should never overspend and contribute more money to your debt. These discretionary purchases should be inexpensive and planned. Budget for a set amount that you can afford and stick to that amount.
If any spending contributes to more debt, it’s a no. The goal is to pay off your debt, not add to it.
How Much to Allocate On Each Debt
Whether you choose the debt snowball method or paying the highest interest rate first, it’s time to allocate your payments across all your debts.
I’ll use these example figures:
We’ll say you have five debts.
- Mortgage, Owe $419,000, min payment $2500 a month, 3.75% p.a. interest
- Car Loan, Owe $17,000, min payment $300 month, 8% interest
- Credit Card 1, Owe $567, min payment $10, 14% interest
- Store Card 2, Owe $1360, min payment $40, 18% interest
- Credit Card 3, Owe $4293, min payment $90, 15% interest
Using the debt snowball method, you would pay credit card 1 off first, paying the minimum on the rest. Then when that’s paid off, you would start working on store card since it has the next lowest balance, and so on.
Staggering Your Payments vs Paying the Minimum on the Rest
Let’s look at both of these.
The Stagger Method
The stagger method is a variation on the main snowball method where you still concentrate on the lowest balance debt first but put more money on the rest of the debts instead of the minimum amount.
So you allocate the highest portion of your funds to the lowest balance debt (or highest interest rate if you prefer that method) and then stagger the amounts for the rest.
Let’s say that after you pay your mortgage at $2500 a month, you have $1000 a month to pay the rest of your debts.
Using the example debts above, you choose to stagger your payments like this:
Credit Card 1: $400 (the most)
Store Card 2: $200
Credit Card 3: $100
Car Loan: $300 (minimum payment)
You’re paying the most to the main debt that you’re concentrating on and above the minimum payments (except for the car payment) for the rest. But at the end of the month you still have all four debts.
The Snowball Method
This is the more common method of the snowball strategy. Paying the most on your main debt and the minimum on the rest.
So, using the example of $1,000 again your allocation would look like this:
Credit Card 1: $570 (the most)
Store Card 2: $40 (minimum payment)
Credit Card 3: $90 (minimum payment)
Car Loan: $300 (minimum payment)
Except you only needed $567 for your first debt so, BAM, that debt is paid and gone. Now you can move onto the Store Card 2 and continue the process until you’re done with that and eventually eliminate all of those debts one by one.
Never pay the minimum on all your debts. Always have one you are working to getting rid of.
As you can see in the second example, paying the most on one debt and the minimum on the rest is going to allow you to see real progress each time you get rid of a debt which is incredibly motivating.
Should You Keep Your Credit Cards After You Pay them Off?
According to ValuePenguin, the average number of credit cards that people had in 2017 was 2.35 with an outstanding balance of $5,551. So having two to three credit cards (with the stats skewing closer to two) is the norm.
While you only need to have one credit card for all your purchasing, there’s nothing wrong with having a backup card.
I don’t mean having that backup card in case you get to the limit of the first and you need to do more shopping, but rather a backup in case the first gets lost or stolen. Having access to a second line of credit in such an emergency can offer peace of mind until the bank sorts out replacing the first one. Usually it’ll take a week or more to get the first restored which can be a hassle while you’re waiting, so having that extra card just makes life easier for you.
I do recommend only using one card at a time though. Not both. Leave the second at home.
Which Card to choose?
The card you decide to use as your main credit card will depend on what’s important to you.
The factors to consider are the interest rate, fees, whether the card has perks or rewards, and if it’s a card that widely accepted around your country and other countries if you travel.
If you can’t pay off your card in full every month, then choosing a low interest rate makes sense. If you do pay it off and never carry any debt, then one of the other factors, like a free travel insurance perk, might be more appealing.
Just make sure you read about the fees on your chosen card. Fee’s on credit cards are often one thing that people don’t look into until they are slugged with a $25 charge once a year that they weren’t expecting.
What about debit cards rather than credit cards?
There has been a growing trend over the past few years to use debit cards rather than credit cards.
What’s a debit card?
A debit card works in the same manner as a credit card (in that you can use it to buy things rather than using cash), but instead of buying on credit, you’re buying with your own money.
There are two ways this can happen.
One is a debit card that is linked to your main bank account and it pulls the funds from there, and the second is a debit card where you put money onto it in order to use it.
There are pros and cons to both.
A debit card that is linked to your bank account is useful because you don’t have to do anything else, but you always need to be sure that you have the money in your account otherwise you might accidentally overdraw with it.
A debit card that you put money on up front is more secure (since it’s not linked to your account), but means that if you lose it, you’ve lost all the money on it. Sometimes also it’s hard to spend every cent you put on and small balances are left on the card.
Debit cards have no interest payments like a credit card (since you’re not borrowing money), but sometimes there are fees associated with them which you need to be aware of.
Next I’ll be going over strategies for finding money to pay off the debts. It’s coming soon.
From the author
Did you find this article useful? It’s actually part of the first draft of a general finance book I’m writing. I’ve decided to blog the book (that is, write the first draft of the entire book on this blog as I go.)
The blog posts might not be in order as I skip around different sections of the book, and not everything I write may end up in print. However, it’s a good strong base for what you’ll find inside.
That means you can watch me write it, and even read the book for free (a few thousand words at a time) if you like.
Or if you want to get notified when I publish it, you can sign up to my email list below (I’m only sending out emails once the book is done and I don’t know how long that will be).
Until the next post, happy reading.
Tracey 🙂
[mailerlite_form form_id=1]
