While some types of debt, like a home mortgage, can help you build long-term wealth when managed wisely, being deeply in debt can feel stressful and overwhelming. Luckily, it is possible to get out of debt. It won't happen overnight — it will take time, planning, and maybe some professional help, but paying off your debt is possible.
Following these steps can help you get out of debt, remain debt-free in the future, and build good credit for the long haul:
List Everything You Owe
In order to pay off your debt, you need to know exactly how much you owe:
- Make a list of all your debts. Include your mortgage, vehicle loans, student loans, other types of loans, accounts in collection and credit cards.
- For loans, note your interest rate and monthly payment.
- For credit cards, note your interest rate and the minimum monthly payment.
Add your monthly loan payments and minimum credit card payments to determine the minimum amount you owe each month.
If you're unsure of all the accounts you may have open, especially those that might be in collections, you can check your free credit report. It will show what creditors are currently reporting to the credit bureau, including your most-recently reported balances and contact information for the accounts. (Your banks and credit card issuers will have the most up-to-date information.)
The total you come up with is the minimum amount you need to pay every month simply to stay current on your debt. However, if that's all you pay toward your debt on a monthly basis, it will be nearly impossible to pay off all your debt.
Decide How Much You Can Pay Each Month
In order to work toward getting out of debt, there are a few more important steps you need to take. Make another list. On this one, include all of your non-debt monthly expenses, such as groceries, cell phone bill, utilities, gas for your car, rent, entertainment, clothing, etc.
Some of these amounts can vary from month to month, so it's a good idea to take the average of several months. For example, to get an average for your electricity bill, add up the total from six months' worth of bills and then divide the sum by six. That's your average electricity cost for the past six months.
This list represents basic expenses that you must pay every month. Now, compare this amount to your monthly income. Consider only the money you have left after paying taxes and other salary withholdings — your "take-home pay" or "monthly net income." Subtract these total expenses from your monthly income.
If the amount you have left over after paying these necessary bills is less than the amount you need to put toward your debt, you'll need to take action. You may choose to:
- Reconsider your expenses and look for opportunities to spend less. For example, if you dine out a lot, cutting back could save money that you can put toward paying off debt.
- Consider debt consolidation. A debt consolidation loan allows you to compile multiple high-interest debts, like credit card balances, into a single lower-interest debt. While debt consolidation can't lower the principal of what you owe, it can reduce the total amount of interest you'll pay over the life of the debt. Reducing interest expenses may make it easier for you to put more money toward paying down the principal of the debt.
- Increase your income so you have more money to put toward your debt. You might get a second job, sell some things you don't need or look for a job that pays more.
If the amount left over after paying basic expenses is more than the minimum amount you need to put toward your debt, decide how much additional money you would like to set aside to pay down your debt each month. Remember, the more you can pay above the minimum, the faster you'll be able to pay off your debt.
Reduce Your Interest Rates
High interest rates can cause your debt to grow rapidly, especially if you have a lot of credit card debt. When you're paying a lot for interest, it can be difficult to pay off the principal.
Here are some common types of higher-interest debt and tips for how to reduce the interest you pay on each:
You have a few options for reducing credit card interest rates:
- You can call the credit card issuer and ask for a lower rate. If you have a good payment history with them and good credit, they may agree to lower your rate for at least a while, or even permanently. Asking for a lower interest rate costs you nothing and doesn't affect your credit report or credit score.
- If you're not able to secure a lower interest rate from your current credit card company, you may be able to transfer outstanding credit card balances to a card with a lower or zero interest rate (called a balance transfer credit card). Credit card companies often offer promotional rates for a limited period in exchange for you transferring a balance from an existing card to a new one. You'll need to meet the balance transfer card company's qualifications, and will probably need to pay a transfer fee that equals about 3 percent of the balance you're transferring.
- A debt consolidation loan can be another way to lower your interest rates, since loans of this type typically charge lower interest than credit cards.
While certain types of student loans can have fairly low interest rates, if your student loans are older, your rates may be higher. Additionally, if you have a high principal, the interest can quickly add up.
Depending on your income and the type of student loan you have, you may be able to apply for an income-driven repayment plan on StudentLoan.gov that will lower your monthly payment. You must be current on your student loan debt to qualify, but you could reduce your monthly payment without incurring a penalty or harming your credit score.
You may also be able to obtain a debt consolidation loan if you have more than one student loan. Consolidating multiple student loans, which you can also apply for through StudentLoan.gov, will allow you to have a single monthly payment at a fixed interest rate that's based on the average of the interest rates on the loans you're consolidating. There's no cost to consolidate multiple federal education loans into one loan. However, you may lose certain student loan benefits, such as the ability to defer repayment.
You may also apply for a debt consolidation loan from a bank or other financial institution that combines your student loans and other debt, such as credit card debt. If you go this route, you may lose student loan benefits, such as the ability to defer repayment.
If you're looking for help dealing with high interest rates and difficult-to-manage debt, you may be wondering if debt settlement is a good option for you. Some debt settlement companies advertise that they will negotiate with lenders on your behalf to get your payments reduced. While debt settlement may make it easier for you to pay off your debt, it does have some significant credit consequences.
Whenever you pay less than the full amount you owe — which you agreed to pay when you entered into a credit agreement with the lender or credit card company — the settlement appears as negative information on your credit report. Negative information can contribute to lower credit scores.
Instead of diving into debt settlement, a better option might be to talk to a nonprofit credit counselor. Credit counseling organizations can help you better understand tactics for managing and reducing your debt, including creating and following a budget. Credit counseling may not have the negative impact of debt settlement (though if you choose a Debt Management Plan, it could appear on your credit report).
Pay Your Bills on Time Each Month
Paying all your bills on time every month is one of the single best things you can do for your credit. Take any steps necessary to ensure you remember to pay your bills. You can set up automatic payments or payment reminders through your bank to ensure you never miss a payment.
If you find you're having trouble juggling all your bills and keeping up with payments, some options that could help include:
- A debt consolidation loan can allow you to replace multiple monthly bills with a single payment.
- A debt management plan can also reduce the number of payments you have to remember each month. A credit counselor will negotiate with your creditors to see if they'll accept reduced interest rates or monthly payments, waive fees or reduce the amount you owe. Then, you pay the credit counseling agency once a month and the organization distributes the funds to your creditors per their agreement. If you enroll in a Debt Management Plan, it could be noted on your credit report.
Of course, you don't need professional help to create your own plan for managing debt. There are multiple ways to pay down debt, including:
- Put extra money toward the debt with the highest interest rate. In the long run, this will reduce the total amount of interest you pay.
- Put extra money toward the credit card or debt with the smallest balance. You'll be able to pay it off quickly, reducing the total number of accounts you have to deal with, and giving yourself the mental boost of successfully eliminating part of your debt (though you'll pay more interest in the long run than if you were to pay off debt with the highest interest rate first.)
- First, deal with any debts that are in collections. Bringing collection accounts current can help reduce their negative impact on your credit. Plus, reducing calls from debt collectors can help relieve some of the stress of being in debt.
Be Diligent Moving Forward
As you work to pay down your current debts, it's important not to undermine your hard work by taking on any new debt. Avoid the temptation to use a personal loan or balance transfer card to consolidate credit card debt, only to run up new debt on the now-paid-off credit cards.
Each time you successfully pay off a debt, put the extra money freed up toward paying off more of your other debts. In months where you make more money than anticipated, or your expenses are less than expected, make the extra money work harder for you by putting it toward additional payments on your debt.
What if You Still Need Help?
Sometimes debt is just too much, and you fear you won't be able to ever repay everything you owe. You do have some last-resort options, including a debt management plan. Bankruptcy is another.
Declaring bankruptcy is one of the most harmful circumstances for your credit, and it should only be a last resort. Depending on the type of bankruptcy you declare, the negative information will remain on your credit report for seven to 10 years. You may either have all your debts eliminated or have to agree to a plan to repay at least part of your debt.
Once you're free of debt, you can begin rebuilding your credit by continuing to practice good credit and financial management practices. Pay all your bills on time, and avoid carrying credit card balances from month to month.