We all know a person who feels stuck paying off their debt. Or, perhaps you’ve found yourself struggling to get out of debt. NerdWallet estimates that as of August, 2015 the average American household has over $200,000 in credit card, student loan, and mortgage debt combined. That’s a big burden to shoulder.
Sometimes, making debt payments feels like a never-ending cycle. It brings stress to our lives and limits our financial freedom. Follow these five tips to help guide you, or a friend, towards a debt-free life.
- Set a goal and make your payment plan work
Establishing realistic goals is one of the important things you need to do to make your plan work. With this in mind, it is crucial to make a plan that ensures direction towards your goal. To begin, you must recall and list all your loans from the smallest principal to the largest. Start making minimum payments on each of these loans and then decide on the maximum amount you can settle to pay the smallest loan per month.
Why the start off with the smallest principal? Because as each loan is settled and paid odd, a larger monthly amount can be carried over to the next smallest loan. This allows a quicker payoff alongside a smaller amount of accrued interest. This method is known as the debt snowball, a favorite of personal finance guru Dave Ramsey.
An alternative method is the debt avalanche route. You focus on the debt with the highest interest rate, regardless of the principal, and then focus on the debt with the second-highest interest rate, and so on. By following this method you’ll pay less in overall interest, but you might not get the moral boost of completely wiping out a debt as quickly as you would with the snowball method.
- Be aware of your spending habits
Ask yourself these questions: Are you spending more than what you earn? Are you a shopaholic? Are you buying things you want or need? Do you like online shopping? Do you like buying things just because they’re trendy?
One way to help you get out of debt is to become aware of, and make changes to, your spending habits. Note – this is not the same as expense reduction or cost cutting.
If you’re not sure where your money is going each month, that’s definitely where you should start. Use expense-tracking software, such as Quicken, Mint, GoodBudget, or Pocket Expense and figure out how, when, and where you spend money. Become aware of your habits so that you can change them.
- Now cut costs and reduce expenses
Once you know what’s happening to your money you can consider cutting back and reducing expenses that aren’t necessary. Think of it this way, every dollar you have can be spent in two ways. You can spend it to buy something. Or, you can spend it to buy back your financial freedom by paying off debt.
Start with your monthly expenses. You might be able to negotiate better rates for your cellphone, internet service, insurance premiums, or bank and credit card fees. If you rent and want to take an extreme step, consider moving to a cheaper apartment.
After a few weeks of tracking expenses, you might become aware of bad money habits you could break. Maybe you spend $15 on coffee a week even though the office has free coffee, or you could make it at home for less.
It is true that cutting costs can be hard to practice initially, but through self-control and discipline, you will be spending your money on only what is necessary.
- Start setting up automatic payments
One of the biggest mistakes you could make is missing a payment. Putting off payments means compound interest will work against you, and you’ll wind up paying more in interest overall. A late or missed payment will also go on your credit record and might make getting loans in the future more difficult or expensive due to higher interest rates.
To make sure you pay every month, it is best to set up automatic payments from your bank account. As an added incentive, some lenders offer a reduced interest rate on your loan when you have automatic payments.
- Consult a professional
Getting out of debt isn’t easy, and sometimes everyone needs a helping hand. Consider consulting a debt or credit counselor that can help you set up a payment plan or budget, work with you, and advocate for you. Be wary of online organizations or people posing as debt counselors.
Look for non-profit organizations that are registered with The Association of Independent Consumer Credit Counseling Agencies or The National Foundation of Credit Counseling. Know that even some non-profits may charge a nominal fee for their services, but they shouldn’t be aggressive or try to push you to buy anything. Counselors may be able to negotiate on your behalf and get creditors to lower your monthly payments.