10 Ways to Pay Down Debt
If you’re like most Americans, you have debt – student loans, car payments, mortgages, and credit card debt. Although lenders bill you for a minimum payment each month, sticking to the minimum could cost you thousands of dollars in the long term. Prioritizing debt is challenging, but following these top ten tips to pay down your debt will help you get started.
1. Make a budget
Before you can make a plan for paying down your debt, you have to assess your cost of living and determine how much money you can allocate to loan payments each month. If you’re having trouble finding enough money for all your bills, read What College Forgot’s articles on monthly budgeting and money saving tips. Free web applications like Yodlee Money Center or Mint.com can make it easy for you to view all of your assets and liabilities (how much you have and owe), and get a picture of your net worth.
2. Understand your debt
When you’re making a plan to pay off debt, take time to understand what you owe. The two main types of debt are secured and unsecured. Secured debt is a mortgage or car loan and often has a fairly low interest rate and a long term of payment. However, if you fall behind on your payments, the lender can seize your house or car. Unsecured debt – often credit card debt – tends to have higher interest rates, but if you don’t make payments, you won’t lose your material assets. Student loan debt falls into a special category. The source of your loan, either the government or a private institution, determines whether it’s secured or unsecured. In most cases, a bankruptcy judge won’t erase student loan debt even if you file for bankruptcy. When faced with tough choices, concentrate on the debt that has the most potential to disrupt your life.
3. Differentiate between good debt and bad debt
Even though you may wish you didn’t have any debt, two types of debt can be good: student loans and mortgages. These types of loans typically have lower interest rates than credit cards and other loans, and, most importantly, tax deductible interest. At the end of each year, your lender will send you a statement with the amount of interest you paid over the year. You can deduct student loan interest from your adjusted gross income, which will reduce your total tax bill. You can do the same with mortgage interest if you itemize your deductions. When you’re prioritizing your debt, pay bad debt first. Continue making minimum payments on the good debt but put all your extra money against the bad debt.
4. Pay down debt with the highest interest rate first
Many people make the mistake of paying down debts with low interest rates before they tackle those with high rates. If you have a credit card with a 12 percent rate and a car loan with a five percent rate, pay down the credit card even if the car loan is for a higher amount. Continue making minimum payments on all your debts because late payments can lead to fees, higher interest rates, and a damaged credit score.
5. Pay more than the minimum
Credit card companies and other lenders carefully choose minimum payments that will maximize their profits. The longer it takes you to pay off a loan, the more the lender makes in interest. If you pay a little more than the minimum payment each month, you can significantly decrease the amount of time it will take to pay down that debt, which also means you’ll pay less in interest. Find out how much this strategy could save you by entering your debt into Bank Rate’s minimum payment calculator.
6. Negotiate for lower interest rates
You can’t negotiate with all lenders, but some lenders – including credit card companies – are willing to lower interest rates for some customers. Call your credit card company and ask them for a lower rate. Tell them you’re considering canceling your card if they won’t lower the interest rate; many credit card companies will lower interest rates in order to keep you as a customer. If they refuse, open up a new credit card with a low rate and transfer your balance. Be sure to read the terms and conditions carefully before transferring a balance – some credit cards have hidden fees and rules.
7. Snowball debt
Snowballing debt is a technique for paying down debt as quickly as possible and is useful for people who feel overwhelmed by lots of different loans. Snowballing is concentrating on one loan at a time. Once you pay off that loan, apply the minimum monthly payment of the old loan plus the extra amount you were paying to the next loan on the list. InterestGrows.com has a free snowball debt reduction calculator that you can use to figure out your payments. There are two schools of thought on how to snowball most effectively:
- Start with the smallest loan – Debt expert Dave Ramsey encourages people to make the minimum payment on all loans except for the loan that's lowest in dollar value. Pay as much toward that loan as you can each month. The goal is to pay off your smallest loan quickly and then when that loan is paid off, move onto the next one. Ramsey argues that the small successes of wiping out one loan at a time can help you stay motivated.
- Start with the highest interest rate – Order your loans by interest rate and pay off the loan with the highest rate first. Again, pay as much as possible on the loan that you’re snowballing each month. This method will probably save you more money in the long term, as long as you can discipline yourself to stick with it!
8. Make all your payments on time
Late payments can cost you a lot of money and end up increasing your overall debt load. Some credit card companies raise interest rates if you have a late payment. If you make all your payments on time, you may qualify for a reduced interest rate. For example, some student loan lenders lower interest rates after a set number of on-time payments. You can avoid late payments by setting up automatic payments through your bank. If a payment is late, pay it as soon as possible, but don’t panic. Many lenders have grace periods and can’t raise your interest rates if you make the payment during the grace period.
9. Put investing on hold
Investing for your retirement is incredibly important, but if you have a lot of debt, you may be better off putting investing on hold. Continue making minimum payments to your 401k only if you get a company match on those dollars, and hold off on any other investing until your bad debt is paid off. Also realize that because most savings accounts have much lower interest rates than loans, it can cost you money to save. Keep a small emergency fund equal to one month's expenses, and put the rest of your savings towards repaying credit card debt and other loans with high interest rates.
10. Stop accumulating more debt
This step is key! Getting out of debt can be a never-ending process if you’re still accumulating debt. Cut up all but one of your credit cards and designate that card for emergencies only. Get in the habit of paying cash or using a debit card for all purchases and stick to your budget to stay within or below your means. With determination, good habits, and time, you can become debt free.
By: Jessica Bayliss
11-10-2009
Jessica Bayliss is a freelance writer specializing in finance and education. She has degrees from the University of Illinois and Texas A&M-Kingsville and is still learning all about what college forgot.
