How to Get Out of Debt
Figuring out how to get out of debt is one of the most freeing things any person can do with their finances. The problem is that so many people do not see how to make their dream of a debt free life a reality.
According to a 2020 study on UK debt, the average UK household was more than £60,000 in the hole last year.
Amazingly, £12,762 of that amount was comprised of credit card debt – the worst kind of debt anyone can have.Of course, other types of debt can hurt our finances, too. Collectively, UK citizens owed £1,684 billion at the end of August 2020. This is up by £26.2 billion from £1,658 billion at the end of August 2019, an extra £498 per UK adult over the year. The average total debt per household, including mortgages, was £60,526. Per adult this was £31,972, around 111.5% of average earnings.
Some of this debt was planned for and is still considered “good debt,” it still takes a toll on our finances – and our lives.
But, how did it get this way?
Sadly, we are programmed to take on and accept debt from the moment we are born. Starting from childhood, we are tempted with a barrage of television ads for cars, boats, and luxury items we can easily finance through any number financial products and loans.
“Twelve months – same as cash” is a phrase we all heard repeatedly growing up.
Can’t afford something? Hey, that’s okay. Just keep up with your loan and you’ll be fine.
Visit a car dealership and the first question you’re asked is how much you can afford to pay each month – not what you can afford to pay over all. And the same is true nearly anything you can buy – from clothing to furniture.
Can’t afford it today?
Just open a store credit card and you can pay it off later, they’ll say. Want to go to college? Just sign on the dotted line and you can borrow the money you need. You might have to pay it back for ten, twenty, or even thirty years, but it will all be worth it, right?
How to Get Out of Debt
If you’re struggling to make ends meet or hoping for a life with less stress and worry, you need to learn how to see debt in a brand new way.
Instead of seeing debt and credit cards as the easiest way to afford what you want, you should start seeing debt for what it really is – a curse that stands between you and your lifelong goals.
There are numerous ways to get out of debt, and not everyone needs to choose the same path. For some people, a slow and steady pace will work just fine. But for others, the desire to get out of debt is so great that they will do anything to speed the process along.
The very first step anyone should take is to sit down with all of their bills and banks statements in order to figure out how much they owe and to whom. Sometimes taking a comprehensive look at all of your debts is the easiest way to figure out where you should start.
And regardless, no matter what, the first step out is debt is coming to grips with exactly how much money you owe.
You may not like what you see, but you’ll have to deal with it either way.
Credit card debt can be crippling. Obtaining a personal loan with a lower interest rate to pay off credit card debt could be a great option.
Once you have confronted your debts, there are several strategies you can use to dig yourself out:
Try the debt-snowball method.
The debt snowball method for debt repayment is often touted as the best and most efficient way to become debt-free. If you choose this option, you’ll start the process by listing all of your debts in order from the smallest balance to the largest.
Once your debt reduction spreadsheet is ready, you’ll create a budget that accounts for making minimum payments on all of your debts except for the smallest one. When it comes to your smallest loan balance, you’ll pay everything you can towards it until it’s gone.
As each small balance is paid off, you’ll move down the list, throwing all of your extra funds at the smallest balance and making minimum payments on the rest. Over time, your small balances will be wiped off the face of the Earth, leaving only your largest balances behind.
Without forced payments on your small balances, however, you’ll be able to snowball your payments towards your remaining, larger loans and get rid of them at a much faster pace.
The biggest benefit of the debt snowball method is that you’ll get a lot of “small wins” early, and reduce the number of monthly payments you’re making at a much faster pace.
Take on the debt avalanche.
The debt avalanche works similarly to the debt snowball but takes a slightly different approach. Instead of prioritising your smallest balances first, you’ll list your loans and balances by their respective interest rates instead.
Each month, you’ll pay as much as you can towards your highest interest debt while making minimum payments on everything else. Over time, your high interest debts will be paid off, leaving only low interest debts. Month by month, you’ll continue attacking all of your balances until they are gone – and gone for good.
While you may pay on some loans longer with this method, using the debt repayment plan of paying off high interest debts first (instead of your smallest balances) will save you more money in the long run.
Pay off debt faster with a 0% APR credit card.
It can be difficult to accept the fact that a credit card might be the solution to credit card debt, but hear me out. In reality, certain types of credit cards, 0% APR and balance transfer credit cards, offer introductory offers that can help you save money and get out of debt.
Consolidate or refinance your debts.
By refinancing certain loans, you may be able to get a better deal and save money in the process. With private student loans, for example, it can make sense to refinance with a different lender to get a loan with a lower interest rate and better terms.
You can also consolidate your high interest rate credit cards with a personal loan.
Consolidating your debts can help you get on a structured payment plan to help you get out of debt faster. Debt consolidation loans are amortised over time (similar to a mortgage) and you’ll end up paying less interest versus paying minimum payments on your credit cards.
Both online student loan providers can help you determine whether you could, in fact, get a better deal with a debt consolidation loan and get that student loan debt out of your life much faster.
If you are way behind on many debts and are unable to pay them off, you may be able settle your debts for a much smaller amount. To do this, you will need to have a lump sum payment that you can offer the lender. This works particularly well with old credit card and consumer debt.
You can also go through a debt settlement company, but you will pay more by using them.
With any type of debt settlement program make sure you get the agreement in writing and keep all receipts so that no one can come back later and accuse you of not paying off the debt.
Drastically cut your expenses.
If you can’t seem to get ahead, you’re probably spending more money than you should most months. If that’s the case, it can pay off to drastically hack your monthly expenses to free up cash.
If you’re not sure where to start, get out your bank statements from prior months to figure out where your money has been going thus far. Are you spending a lot of money dining out at restaurants? Are your trips to the mall hurting your bottom line? Are your car payments killing your budget?
The easiest way to hack your spending plan is to start with the low-hanging fruit.
While you’re trying to pay down debt, stop dining out and start cooking at home. Quit destructive habits like smoking if you can – or at least cut down.
Take a close look at your grocery budget, too. If you’re spending a lot of money on food each month, focusing on cheap and easy meals for a while can help you cut back. Also, look at your “discretionary bills,” and consider cutting them out of your life. If you’re paying a lot for cable television, smartphones, entertainment, or subscriptions, it can pay off to cancel those services while you focus on paying off debt.
Just remember, any amounts you cut from your budget need to be thrown at your debts in whatever order you see fit. If you end up spending that money elsewhere in your budget, you aren’t really helping yourself.
Get a part-time job or pick up a side hustle.
Once you have figured out the best way to pay off your debts and cut your spending, the other way to speed up your journey is to pick up a side hustle or take on a part-time job. By earning income through additional labor – or through passive means – you can earn more cash you can use to pay down debt faster.
There are myriad ways to earn extra money if you look hard enough. Depending on your situation, you might be able to pick up more hours or even overtime at work. Or perhaps you can start a side job or hustle you can run from home. You can also look into becoming a Uber Driver, which is a great side hustle because you can create your own schedule according to your flexibility and schedule.
Mow yards. Trim hedges. Start a small painting business from home. Pick up freelance writing and editing jobs. Babysit your neighbours kids or pets. Pick up overtime at your full-time job. Wash cars, run errands, or house sit.
If you’re creative enough, you’ll find there are plenty of ways to earn extra cash. And once you start earning, you’ll be able to accelerate your debt payoff.
Online Tools to Help you Get Out of Debt
If you have debt but have maintained a good credit score you may be able to expedite your payoff plan by getting better credit offers to move your debt to.
First, a word of warning. You will never pay off your debt if you don’t get serious about sending in extra principal payments each month. You can work more, cut back, or do both to get that extra money to pay down the debt faster. Moving your debt from one company to another can help, but you can’t play hot potato with your creditors and hope to get out of debt fast.
That having been said one of the best ways to cut your interest is to lower your interest rate. And that’s exactly what Credit Karma does for you.
The company automatically pulls all of your credit, debt, and payment information from your credit history for no charge. They then use this data to compare to other offers with their credit partners in order to save you money.
For example, you might get a refinance offer for your mortgage and a balance transfer offer for one of your balances. Not only will these offers save you money, you will be able to plainly see through Credit Karma exactly how much money you will save.
One last thing: you get access to a free credit report each month. This report isn’t your FICO score, but still holds some value as you track the ups and downs of your score.
Experianis very similar to Credit Karma with just a few slight differences. Just like Credit Karma, the company pulls your debt and payment information to offer you better credit offers.
Here are the differences:
- Experian will update your credit score daily versus monthly for Credit Sesame. (You have to manually login and click update to get the daily score, but you can get it daily.)
- Credit Karma uses a different credit bureau score than Credit Sesame. However, they are similar in that they are both non-FICO scores.
- The company offers a Credit Report Card can help you understand why you are receiving a certain score. Is it too many recent credit inquiries or an error on your credit report? The Credit Report Card helps you with that.
It doesn’t hurt to track two of your free credit scores online, so we recommend signing up for both Experian and Credit Karma. Sign up for Experian here .
If I Receive a Large Sum of Money Should I Put it All Toward Debt?
This is a great question for people who are just starting to pay off their debt and come into an inheritance or other windfall. What is important is that we set ourselves up for success not just paying off debt.
Make Sure You Have a Savings Cushion
The question involving windfalls, and particularly inheritances, is almost always between paying off debt or investing. I would suggest that there is a third option that can’t be overlooked in a lot of cases.
Before you either pay off debt or invest for the future, the first thing you need to do is to create a cash cushion for the present.
One of the biggest reasons for financial stress– and even for the inability to achieve long-term financial independence – is a lack of liquidity. The absence of any kind of liquid savings forces you to rely on debt any time there is a cash shortage.
It doesn’t take much imagination to realise that an absence of savings is a surefire recipe for a lifetime on the debt treadmill. Unfortunately, it starts early with most people. Because they never have a basic savings account, credit dependency becomes a lifestyle. Debt can suck the life out of your finances, because it represents a perpetual drain on your income.
In addition, having enough savings to cover your living expenses for a few months will do more to reduce financial stress in your life than just about any other single strategy. It eliminates worry over an unexpected expense, or even a temporary loss of a job.
For all of those reasons, my recommendation would be to first make sure that you have enough money in a savings account or money market fund to cover your living expenses or at least three months. That will give you the breathing room that need to do everything else.
The Case for Paying Off Debt
Using an inheritance to pay off a debt is usually a can’t-miss strategy. That’s because the rate of interest that you pay on debt is just about always higher than what you can in an interest-bearing account. For example, if you’re paying 20% on your credit card debt, but you can earn no more than 1% in a savings account, you’ll be losing 19% per year if you put the money into savings, rather than toward paying off your credit cards.
Still another factor is income tax. Interest earned is taxable, while interest paid on consumer debt is not tax deductible. That means that even if the spread between interest on debt and interest on savings were closer, the tax imbalance would continue to work against you.
Some financial advisors recommend that you eliminate consumer debt, particularly credit cards and other unsecured lines of credit, before you even begin investing. While I don’t necessarily believe that advice applies in all cases, it’s still a sound strategy.
After all, the elimination of a debt with a 20% interest rate effectively translates into an investment that pays 20% guaranteed!
There’s also an imbalance in regard to rate of return. For example, the interest rate that you pay on debt is usually locked in. But the return that you earn on your investments is not, at least in the case of equity investments, like stocks and mutual funds. In fact, those asset values can drop in a market decline, while your debt level will only fall to the extent that you make payments to reduce it.
Then there’s the point that by paying off debt, you free up your income for other purposes, including savings and investments. It’s often true that people who have a lot of debt are never able to save and invest. By paying off debt, you will be in a position to do just that, and that can change your financial life for the better forever.
You really can’t go wrong with paying off debt.
The Case for Investing the Money
A strong case can be made for investing an inheritance. This is especially true if you currently have no investments, and don’t have any history of having them.
Sometimes the money from a windfall can jump start you into investing. You get a basic nest egg to invest, and then you start adding periodic contributions to the account. The investment then grows steadily, through a combination of continuing contributions and investment returns.
Long-term, this is a sound strategy. Your wealth will grow along with the size of your investment portfolio. As you become wealthier, it’s entirely possible that your debt problems will eventually become smaller. That is, the amount of your investments can outstrip the size of your debt. When it does, you’ll be in a position to both pay off your debt, and still have investment assets for continued investing.
This can be especially true if the investing is being done through some sort of tax-sheltered savings, like a Stocks & Shares ISA. The fact that you have an inheritance can even free up more of your paycheck to contribute to an employer-sponsored plan.
In a tax-sheltered plan your investment value grows even faster, because there is no tax liability to reduce your rate of return. This is a way to build your investment worth quickly. And it goes without saying that it creates the kind of long-term financial stability that can improve your entire situation.
My Recommendation for Using a Windfall With Debt
Every circumstance is a little different, but in most cases, I would suggest a person choose the following – in order:
- Set up a savings cushion. The first recommendation is that you put enough of the windfall into a savings account or money market fund to cover at least three months of living expenses. The savings cushion will give you the room you need to manoeuvre to seriously attack paying off her debt.
- Use the balance of the inheritance to payoff debt. Obviously setting up the savings cushion will leave her with even less money to pay off her debt. But it would also leave her in a stronger financial position. By using the remaining balance to pay down her debt, you will also lower her your debt payments. Any savings from those reduced payments should be applied to paying off the credit cards sooner. You should also look to find any other ways to either reduce your spending or increase your income to pay off the debt completely.
- Begin investing only when the debt is paid off. Investing for the future has a lot of advantages, but in Katie’s particular situation I think that her priority has to be centered on improving her current circumstances. If you invest money immediately, you risks losing some of the money – without improving her situation. But if you create a savings cushion and pay off your debt first, you will be in a better position to throw everything you have at investing later on.
Don’t Let Debt Stand in the Way of Your Dreams
These days, living with debt is the norm – not the exception. Nearly everyone you and I know is struggling with some form of debt. Worse, most people are letting it hold them back from their dreams.
The best thing you can do for yourself – and your finances – is to pay down debt and avoid it like the plague. Try not to keep up with others, and instead, build an enjoyable and realistic lifestyle you can actually afford.
Debt may be normal these days, but you don’t have to be. Dare to be different, and you’ll be much happier – and much richer – in the long run.