How to pay off credit card DEBT and student loans
Debts, particularly those from credit cards and student loans, are a significant financial burden due to their high interest rates. My personal journey with debt started when I married my wife, who had student loans. Together, we developed a strategy to tackle the debt.
For context, at the time, her student loan debt was $110k, and the interest rates ranged anywhere from 6.5% to 8.5%. Right away we started paying off as much as we could afford into the highest interest loan. The goal was to tackle one loan at a time, starting with the loan with the highest interest. It took us about 24 months to pay off that loan, which felt like an accomplishment and a huge weight lifted off our shoulders. We continued through the pandemic to tackle the other 2 loans, although at a slower pace since the loans did not have interests for a 3 year period. Instead, we put that money towards growing our retirement accounts.
In this article, I summarized the steps we took to tackle high-interest debt with the hopes that it may be helpful to others going through the same journey.
Create a Budget
The first step to tackling high-interest debt is to create a budget.
Arrange your debt from highest to lowest interest rate
Every debt you have will have a different interest rate. Credit cards will usually have the highest rates and should be priority number one. After that it could be anything, a home equity loan (i.e. Heloc loans), car loan, student loan, personal loan. Write down the interest rate and the loan amount of each debt you have.
Pick your strategy to pay down the debt
There are two commonly suggested strategies when tackling debt. The first strategy is known as the “Debt Snowball Method.” This debt reduction strategy involves paying off your debts in order from smallest to largest. You start by making the minimum payment on all of your debts and putting any extra income towards paying off the smallest debt first. Once you have paid off the smallest debt, you take the money you were putting towards that debt and use it to pay off the next smallest debt. You continue this process until all of your debts are paid off. The “debt snowball method” is preferred by some financial experts because it provides the individual with a sense of accomplishment as they pay off their debts one by one, as well as, reduces your monthly expenses allowing you to put more money towards the next debt. I find that this technique is most helpful to those who need some extra help staying motivated and committed to paying off their debts.
The second - and my preferred - strategy is to pay off the highest interest loan first. This saves you the most money since you are paying back your most expensive debt first. Every dollar you pay back is a dollar you won’t get charged interest anymore. Keep in mind that this strategy might be a little slower than the snowball method, especially if your highest interest debts are big loans that will take years to pay back. In that case you might be better off using the snowball method.
Pay more than the minimum payment
It is important to mention that if you only make the minimum payment on your debt or loan each month, it can take years to pay down your debt. This is because most of your payment goes towards interest and only a small portion goes towards actually paying down the principal balance.
To tackle high-interest debt, you should aim to pay more than the minimum payment each month. This will help you pay off your debt faster and save money on interest charges. Even adding an extra $50 or $100 to your payment each month can make a significant difference. If you can afford to pay off more, do not hesitate.
Consolidate your debt
Consolidating your debt can be an effective way to tackle high-interest debt. Debt consolidation involves taking out a loan to pay off all of your existing debts. This allows you to consolidate multiple high-interest debts into one lower-interest loan.
There are several options for consolidating your debt, including:
Balance transfer credit cards: Some credit cards offer a 0% introductory APR for a certain period of time, typically 12-21 months. You can transfer your high-interest credit card balances to these cards to take advantage of the 0% interest rate and pay off your debt faster by actually having all of your payment go towards the principal instead of mostly interest. The bank will usually charge you 3% to transfer fee to move the debt to the credit card, but that’s a lot lower and cheaper than the interest rate on most debts. You do have to make sure that you can pay off the debt you carried into these cards by the end of the free interest period or you might find yourself with a debt that has an even higher interest rate than the one you transferred over.
Personal loan: You can take out a personal loan to pay off your high-interest debts. Personal loans typically have lower interest rates than credit cards and other high-interest loans but not by much. It depends on your credit score and what you qualify for.
Home equity loan: If you own a home, you can take out a home equity loan to pay off your high-interest debt. Home equity loans typically have lower interest rates than credit cards and personal loans, because they are secured by your home. This means that if you can't make your payments, you risk losing your home or having a lien on it. Home Equity loan interest rates also vary a lot depending on your credit score, and the current market, so make sure the effective interest rate is actually lower than the debt you are planning to pay off. Interest rates don’t count fees to originate a loan, so make sure you take those fees into consideration before transferring debt. Below you can see a yearly cost comparison between debts held at different rates.
Seek professional help
If you are struggling to tackle high interest debt on your own and the suggestions above are not enough to give you confidence in your ability to handle your debt, seeking professional help can be a good option. There are several types of professionals who can help you with debt management, including:
Personal financial advisor: An advisor will go over your budget and give you their professional perspective on your personal finances. They will be able to tell you whether you are on a good path or if you need to think about reducing an expense that maybe you didn’t think was possible.
Debt settlement companies: Debt settlement companies can negotiate with your creditors to settle your debts for less than what you owe. However, they often charge high fees and can have a negative impact on your credit score. I would only recommend this option if you have looked at all the other options and you are considering filing for bankruptcy.
Bankruptcy attorneys: If you are unable to pay off your debts through other means, bankruptcy may be an option. Bankruptcy attorneys can help you navigate the bankruptcy process and determine whether Chapter 7 or Chapter 13 bankruptcy is right for you.
Before working with any professional, make sure to do your research and choose a reputable and trustworthy provider.
Avoid taking on new debt
To tackle high-interest debt, it's important to avoid taking on new debt. This means avoiding using credit cards for unnecessary purchases, avoiding taking out new loans, and avoiding other forms of debt, unless their purpose is to transfer high interest debt to low interest ones.
If you need to use credit cards for necessary purchases, make sure to pay off your balance in full each month to avoid accruing interest charges and late fees.
Stay motivated
Tackling high-interest debt can be a long and difficult process, but it's important to stay motivated and committed to your goals. Celebrate small victories along the way, such as paying off a small debt or reaching a savings goal.
You can also stay motivated by tracking your progress and visualizing your debt-free future. Set specific goals and create a timeline for achieving them. This will help you stay focused and motivated as you work towards becoming debt-free. If a debt that has a high interest rate seems too big to handle first, tackle a smaller one first to keep you motivated and to free up cash flow to tackle the other.
Overall, if you have credit card debt, personal loans, or other high-interest debt, it's important to develop a plan to tackle it as soon as possible. By developing a plan and sticking to it, you can take control of your finances. It's important to remember that tackling high-interest debt is not usually a short term goal but a continuous process. Even after you have paid off your debts, you should continue to practice good financial habits to avoid falling back into debt.