Credit cards, car payments, student loans, mortgages . . . the average American is swamped in debt. In fact, according to Fortune Magazine, the average American household has $204,992 worth of debt hanging over its head, and with the American median income hovering around $55,192, that will take quite a while to pay off.
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How can you possibly dig yourself out of that cavernous hole of debt? By prioritizing the debts you pay off, doing a careful budgeting inventory, and using thrifty spending habits – that’s how.
1. Start With High-Interest Loans
If you pay off your high-interest debt first, it will be cheaper in the long run, particularly if one of your credit cards has a much, much higher interest rate than any of your others.
If you have $5,000 on a credit card with an 18% interest rate, you’ll shell out about $74 per month just on the interest; conversely, a similar debt on a card with a 12% interest rate will just set you back $49.
The more you pay onto that high-interest card, the lower those monthly interest payments will go, and less of your hard-earned money will be spent on paying off bills.
2. Use A Low-Interest One For Motivation
The AARP has some unorthodox advice for paying off your debts: while you should focus on the high-interest debts to get them out of the way, you should also kick some money over to a large low-interest debt so you get the satisfaction of watching it drop.
The trouble with high-interest debts is that so much of your money goes into paying the interest that you see very little difference in the total debt owed, which can make you feel like you’re running on a treadmill; if you pay $100 to that 18%-interest credit card, your balance the next month will drop from $5,000 to a less-than-impressive $4,975.
This is hardly going to make you feel motivated. On the other hand, if you pay $100 to the 12%-interest credit card, you’ll watch your balance drop below $4,900 in two months, which may be all the motivation you need to keep paying off your debt.
If you feel like giving up after three months of paying off your high-interest debt first, alternating or splitting your payments between a high-interest and low-interest debt may be a good way to go.
3. Take A Hard Look At Your Expenses
To get a good idea of how much you can free up to pay off debts, you need a monthly budget. Firstly, tally up your monthly income, and then add up your absolute written-in-stone expenses that basically stay the same from month to month: rent or mortgage, car payments, insurance, and so on.
Next, go through your receipts and bank records to find how much you spend per month on other expenses, like groceries, utilities gas, clothes, school supplies, gifts, entertainment, and eating out.
Not only will you find out how much money you have to spend on repaying your debts, but you may discover that you spend far more on frivolities than you expected.
4. Cut Back On Some Luxuries
You may look at your expenses and discover that you usually spend more than you make in which case you need to cut back on luxuries just to make ends meet. On the other hand, you might find out that you have a free $200 per month floating around that you can allocate to debt relief in which case cutting back on luxuries will just let you pay off your debts even faster.
Either way, find something that you can give up on. It may be saving red meat and sushi for a once-a-month splurge, making your own coffee six days a week and just enjoying a frap as a TGIF treat, eating out two fewer days per week, buying most of your clothes at a mid-level department store . . . you get the picture.
An important note, however, is to be realistic. If you decide to cut all luxuries cold turkey or to set extremely spartan standards for your lifestyle, you’re setting yourself up for failure; you may swear up and down that you’re not going to spend a dime on entertainment until your debts are paid, but when the next movie in your favorite franchise comes out, you’re going to cave.
Take things slowly. You can always set stricter standards later.
5. Create A Budget That Includes Debt Relief
Make a budget based on your expenses, including the expenses you’d like to cut back. For instance, if you discover that you typically spend $600 on groceries and honestly don’t think you can spend less, allocate $150 per week; if you typically spend $300 per month eating out and think you could go out half as much, allocate $150 per month to eating out.
Put whatever’s left over into paying off your debts.
To make sticking to your budget easier, you may find it easier to take frequent expenses like groceries, restaurants, gas, and entertainment and divide your monthly budget totals by four to create a weekly budget.
That way, you don’t have to worry about blowing through your entire monthly dining out budget in the first week of the month and having nothing left over a week later when your friends invite you for a birthday bash.
5. Track Your Expenses
If you go over budget, your debt repayment is going to be the first place where you dip in to cover the difference; after all, you won’t notice much if you miss one credit card payment, but missing one utility payment could lead to the lights being turned off.
The trouble is that if one payment turns into two, then three, then four, you’re no closer than you were before to getting out of debt. To avoid this, be a stickler about tracking your expenses and staying within budget.
Different people have different strategies for doing this; there are plenty of budgeting apps that let you track your budget on your phone, or you might prefer a lower-tech alternative like keeping your budget posted on your fridge. Whatever it takes, keep track of what you’re spending so you can keep the debt payments coming.
7. Avoid New Debts
It should go without saying, but if you’re trying to pay off your old debts, you should avoid adding any new ones. Sometimes it’s inevitable – your car dies and you need to take out a loan for a new one, or you have a massive home repair or medical bill and don’t have the savings to take care of it out of pocket.
If it’s a matter of updating an appliance or piece of furniture that still has a few years left on it, however, or of getting a completely new wardrobe so you’re in style for the season – wait. Don’t add any more to the credit card debt that you’ve worked so hard to erase, and don’t open a new account that you’ll just have to pay off again. The new furniture and wardrobe will still be there when you’re debt-free.