How To Pay Off Debt Fast (And Not Go Senseless While Doing It)

There can be no doubt that Americans have a fair amount of debt. According to numbers from the New York Federal Reserve, consumer debt from the fourth quarter of 2018 totaled $13.54 trillion. Here are a few key data points from the report:

• Housing represents our biggest category of outstanding debt as Americans are currently paying off $9.1 trillion worth of home loans.
• The cost of education keeps rising with the amount of outstanding student loan debt going up in the fourth quarter to a total of $1.46 trillion.
• In terms of auto loans, Americans have $1.27 trillion outstanding.
• There’s $870 billion worth of credit card debt outstanding in America. This is some of the highest interest debt out there.

There are a lot of big numbers there. Although not all debt is bad debt, this should give you some idea of the scope of the problem. Moreover, know that if you’re struggling to conquer your debt, you’re not alone.

But how do you go about taking down your personal debts once and for all? The rest of this post will help you wrap your mind around the problem and look at how you can take debt down.

The first step to getting a handle on your debt is determining the scope of the problem. To begin, make a list of your monthly debt payments. Next to the payment, put the interest rate you’re paying on the debt. We’ll use it later.

Next, make another column that looks at the expenses you have every month not related to debt or paying off loans. These could be anything from food and utilities to entertainment and a gym membership, for example.

Now add in your income. After setting aside money for the payments on your debt that have to be made and expenses, how much do you have left? You should put as much of this toward your debt as possible. But before getting that far, how do you prioritize which debt to pay off? For that, let’s move on to a brief discussion of debts that are good compared to ones that are bad.

Debt is an easy thing to hate, but it’s important to note that not all debt is equal. In fact, there are some situations in which debt can be good, if it’s responsibly managed. It’s important to know this because at some point in our life, even the most responsible among us will probably end up taking on some debt. How many people do you know that have $300,000 lying around for a house?

So what are the criteria for good and bad debt? Let’s briefly go over some questions you can use to ask yourself whether you should take on any given debt.

• Will taking on this debt now help me better my financial position in the future? Examples of this might be student loans so you can graduate with a degree and get a higher income. It’s also often beneficial to take on a mortgage (if you can afford it) and not give your money to a landlord. On the other hand, if you’re using the money from the loan to solve a short-term financial struggle and will end up paying a ton more in interest than you currently owe, it may be worth exploring other options.
• How much debt would I be taking on and how long would it take me to pay off at my current income? This is all about some basic math. If you’re making $75,000 per year, it’s a lot easier for you to pay off $100,000 in debt than it will be for someone making $35,000, so that has to be part of the equation, as well.
• If I’m buying something with the loan, do I need it now or can I save up? You might just need a car to get to work. Not every city has great public transportation, unfortunately. And if you really need that car or to cover a medical bill, it makes sense to take the loan. On the other hand, if you don’t need it now and can save up to get it with a smaller loan or without taking on any debt at all, that may be the way to go.
• Can I get the money some other way without taking out a loan? We’ll get into this more later when we talk side hustles, but do you have another way to make some money? Depending on the situation, taking on another gig for some period of time could be preferable to taking on additional debt. If on the other hand, you’re already working 50 hours a week and you’ve turned over every couch cushion, taking out a loan for something you need is not a bad thing.

As you can see, nothing is really black and white, but these questions will help you evaluate the situation. That’s not to say there isn’t a spectrum, and some loans have the potential to lead to more trouble than others. Let’s run through a few common sources of debt.

Credit Cards

When used responsibly, the credit card has a number of advantages. Making reasonable charges to your credit card and paying it off every month can help you build good credit, not to mention those rewards points – flight to London paid for with airline points – yes please!

However, the trouble comes when you start carrying a balance month-to-month because of the very high interest rates associated with that seductive piece of plastic. The average rate on a variable interest credit card is nearing 18% at the time of this writing.

Many credit card companies require a minimum payment of at least 2% of the loan balance. If you had a $1,200 balance and made the minimum monthly payment ($24) at 17.85% interest, it would take you a little over six years to pay off the balance and you would be paying $1,013 in interest.

Personal Loans

Personal loans may be used to fund things like projects around the house, purchases of needed items or even debt consolidation. Personal loans can be very useful as long as you’re diligent about paying them off.

The thing that makes them particularly useful for debt consolidation is the fact that they’re unsecured, so you don’t have to worry about having a certain amount of equity in a piece of collateral like a home. The interest rate also may be lower than what you would pay on a credit card, so consolidation enables you the ability to save some money.

On the flip side, the interest rates aren’t as low as loans that are secured by a piece of property, so the interest rate is a little higher on a personal loan. Because of this, you have to make sure you’re in good enough financial shape to take these loans.

Auto Loans

Auto loans are secured by collateral, so the interest rate will be lower than what you would get on a personal loan. The rate of interest is also affected by how much you put down and your credit. We’ll get into that a little more later.

If you need the car and the loan is within your budget, an auto loan is going to be right for you. What you don’t want to do is purchase a car with a loan that’s beyond your budget.

Mortgage

Getting a mortgage isn’t for everyone at every stage of life, but in many cases, this can be a good loan to take because it may be cheaper than renting and instead of giving your money to a landlord, you build equity in your home. The advantage of equity is being able to refinance to pay off debts, do home improvement projects or maybe catch up on retirement or college fund savings.

The important thing to remember about getting a house is that you do have to have a down payment, and you have to make sure you can afford the payments. If you don’t think you can afford a home at this point, renting will give you an opportunity to build up a payment history so that when you are ready to buy a home, you’re able to show responsibility to the lender which will help you secure an approval.

Student Loans

Higher education is one of the best ways to better your career prospects. According to a recent Business Insider article, college graduates have significantly higher earnings than those that didn’t graduate from college by a significant margin in every state, so if you need to take student loans, it’s something that will likely pay off in the future for you depending on what field you get into.

However, the fact of the matter is that college keeps getting more expensive, so you’ll have to have a plan to tackle that debt.

Payday Loans

Payday loans allow you to cover a short-term cash gap and need to cover some expenses. However, they can come with some significant downsides. To begin with, they come with some really high interest charges and it’s not uncommon to see an annual percentage rate (APR) of nearly 400%.

You should really avoid getting a payday loan if you can.

A key number to be aware of when thinking about your debt is your debt-to-income ratio or DTI. At its most basic level, your DTI is a ratio that compares your monthly debt payments to your monthly income. It includes both revolving debt with changing balances like credit cards as well as debts with installment payments like your auto loans, mortgage, personal and student loans.

Here’s a look at the equation for DTI:

Let’s take that and do a quick example. Your income is $60,000 per year and the following are your bills on a monthly basis:$300 in credit card balances
$250 car payment
$600 student loan payment
$1,100 in a monthly mortgage
 This means that your DTI equation comes out to $2,250/$5,000 meaning you have a DTI of 45%. Then the next important question that follows is why DTI even matters. DTI is the basic metric all lenders use to determine the amount of money you can borrow. It comes into play in everything from car loans to personal loans and mortgages. As an example, when looking to qualify for a mortgage, most lenders and mortgage investors like to see a DTI of no higher than around 45% in order to qualify you for the most possible mortgage options. If you get any higher than that, you may still have options, but there will be fewer of them available. Not every bill you pay is included in your DTI. DTI calculations only include credit card payments and loans that are reporting on your credit. As you can see, the lower your DTI, the better. If you can make more income, great. That’s not always immediately realistic, so the other thing you can do to get your DTI in line is pay off debt. As a first step toward doing that, let’s help you come up with smart strategies to allocate your money to the right places.

Budgeting can sound like a chore, which is why I dress it up by saying “allocate your money to the right places.” However, setting up a budget doesn’t need to be hard.

Add up your monthly expenses including all the bills you have to pay (minimum payments plus food). Once you have these down, put in your monthly income. If it fluctuates, figure out what your lowest monthly income has been for the last several months so that no matter what, you’ve covered your expenses. After taking money out for your basic expenses, write down what’s left over. This is the money we’re going to use to pay down your debt.

For those of you whose income changes month-to-month, when you have a good month, you’ll be able to put more money toward your debts.

Once you know how much income you have to pay down your debt, what are the best ways to reduce your debt in an efficient manner? Let’s go over a few strategies.

Increase Income

When you’re trying to reduce your debt, one of the most powerful things you can do is increase the income you have to pay off your debt. Obviously, that’s easier said than done, but here’s where creativity comes in.

This is your chance to explore passions you don’t get to itch in your day-to-day work life. Do you play music or do creative writing? Are you really good dealing with data? Are you good at making things either digitally or with your hands?

We’re also living at a time where there are a lot of little things you can do to earn extra money from giving rides to delivering groceries to things you can do on your computer at home. The world is really your oyster.

Spending Less

Another way to find more money in the budget to pay down your debt is to find those areas in which you can cut expenses. Of course, you also don’t want to give up life while you’re paying off your debt, so here are a few ideas on ways you can trim the fat while still enjoying life where you can.

• Brown bag it instead of going out to eat: When I use the cafeteria at work, what I get on a regular basis costs me around $12. If I leave the building, it costs more. By contrast, when I bring my lunch, it costs about $1.50. Therefore, I save myself about $10.50 by bringing my lunch. That’s not to say that once a week or once every other week I might not grab lunch with coworkers, but if eating out is something you do on a regular basis, you might be able to find some extra room in your budget right there.
• Cut unused subscriptions: If you have a couple of streaming services, do you really need to keep them both or can you get by with just one? What about all the premium channels on cable that you discover are just showing the same six movies on heavy rotation after a while. I like Shawshank Redemption as much as the next guy, but I only need to see it twice a year. A popular New Year’s resolution is to get healthy and many people don’t end up going to the gym nearly as much as they thought they would after signing up. If you fall into that camp, remember that the health of your budget can also impact your physical health due to increased stress. Walking outside also has the added benefit of the sunshine.
• Become a master negotiator: If it’s been a while, you might want to look at renegotiating some of your contracts. For example, there’s a reason there’s a business school maxim that it’s cheaper to keep an existing customer than to acquire a new one. Companies will give you deep discounts in order to entice you to switch because they realize that switching services and potentially dealing with installation is a pain in the neck. Unless there is a strong push, consumers will deal with an existing provider rather than go through the hassle. But if you’re willing to jump through a couple of hoops, it could be useful to renegotiate your cell phone and cable contracts when they’re up. You could even get a couple of companies to compete for your business by letting your current provider know you’re planning to switch and seeing what they say to try and keep your business.
• Get creative: Just because you’re saving to pay down your debt doesn’t mean that you have to have no life. There are plenty of good, relatively cheap ways to have a good time. Going to movies is cheaper than going to sporting events or plays. Maybe instead of eating out, you pick a nice day and celebrate an achievement with a picnic in the park. There are all kinds of free or relatively inexpensive public attractions available to residents of areas. I can’t tell you how much fun my family has had playing silly card games over the years.

Once you’ve extracted as much money as you can from your budget toward paying off your debt, what are some good ways to reduce debt fast?

Highest Interest First

One way you can tackle your debt problem is to pay off the debt with the highest interest first. This way you save money over time by paying less in interest. This makes the most sense to a lot of people because interest is for the benefit of the bank, not you.

In this method, you would make the minimum payment you had to make to stay current on all your accounts/loans and then put any extra money you have left over every month toward the balance you’re paying the highest interest on in order to get rid of it faster.

Highest Monthly Payment First

If you’re looking to get approved for a loan in the near future, one thing you can do is work toward paying off the debt with the highest monthly payment. The key reason for this is that DTI is based upon monthly payments, so any big amount you can eliminate from your monthly debt reporting will be extremely beneficial.

The downside of this is that you might end up paying more in interest if you have balances that include a higher financing charge. It really depends on what your goals are.

The Snowball Method

If you’re the type of person that needs to see results and feel a real sense of accomplishment in order to stick with something, the snowball method might be for you. How does this work?

You pick the account or a loan with the smallest balance and then put as much money as you can toward it in order to pay off the loan and see quick results. Then you move on to the next largest balance and your payoff journey keeps gathering momentum and eating up more debt just like a snowball rolling downhill.

The primary disadvantage to this method is that you could end up paying more interest if you pick something with a smaller balance but a lower interest rate than something that has a higher balance and a high interest rate, but it's a gratifying way to see progress quickly when debts are wiped off your credit report.

Your debts affect your credit score in a few ways. Let’s break this down a little bit before wrapping up this post. Your debts affect your credit rating and FICO^® Score in the following ways:

• Payment history: As long as you make the minimum payments on your debts each month, it has a positive impact and your credit score should rise. If you’re 30 days or more late on your payment, it’s reported to the credit bureaus and your score will drop. Late payments remain on your credit report for 7 years.
• Collections and charge-offs: In a collection, creditors sell your debt to an agency who then works to try to collect the debt you owe. In a charge-off, your creditor gives up on trying to collect altogether. You may stop getting things in the mail, but a charge-off does have a negative impact on your credit score. According to Equifax^®, these accounts remain on your credit for 7 years.
• Foreclosures or repossessions: If you have a mortgage and you don’t make your payment for long enough without working out a deal with your loan servicer, you’re subject to foreclosure, meaning you lose your home. For loans secured by any other piece of property, that’s known as a repossession and they also take back the securing collateral. Both of these items remain on your credit for 7 years.
• Bankruptcies: If you get to the point where the only way to get out from under your debt is to declare bankruptcy, those remain on your credit report for 7 – 10 years depending upon the type of bankruptcy you file.
• Paid as agreed: These items actually have a beneficial impact on your credit score (although not as much as something paid in full) because it shows you’ve taken the initiative to reach out and deal with your debt. These items stay on your report for 10 years.

The best way to see how your credit report is impacting your score is to monitor both your report and score regularly. With Rocket Homes^SM, you can see your VantageScore 3.0^® credit report and score from TransUnion^® for free once a week. In addition to the raw information, you’ll also get personalized tips on where you can improve.

These tips should help you come up with a plan to cut your debt down to size. If you have any doubts about your plan of action, we encourage you to speak with a financial advisor. Now go forth and pay off that debt!