How to Get Out of Debt: The Ultimate Guide
While paying off debt is a difficult, cumbersome process, we all know just how easy it is to bite off more than you can chew. You borrow money or use your credit card thinking it will be easy to pay it off, but then, life happens. All of a sudden, your debt load spirals out of control and you’re left wondering what happened.
As it stands, the biggest debt burdens carried by Americans today are mortgage debt; student debt; credit debt; home equity debt; and auto loan debt.
Fortunately, there is hope for people who are drowning in debt. You can get out, so long as you’re willing to buckle down and figure out your options.
People like Boston-based writer Candice Latham have proven that with enough passion and dedication, even the worst debts can be overcome.
After graduating from college, Latham found herself with $38,500 in student loans and around $5,000 in credit card debt. But after buckling down, she slayed all her debt except for $992 – an amount she is set to squash very soon.
If that sounds like a lot of debt, it’s not unusual. According to Pew Research Center, the median debt load for someone with a bachelor’s degree was $25,000 in 2016.
Unlike her fellow students who may pay on their loans for a decade or more, Latham wanted to do something different. After making the minimum payment on her student loans for a few years, she sat down with nine friends to construct a debt challenge in 2015. Everyone paid a small fee to enter, and the goal was seeing who could pay off the most debt in 11 weeks. In the end, the winner would win $500.
During that time, Latham says she paid off her smallest student loan of $4,500. From there, she was hooked on the idea of becoming debt-free. And now that she’s $992 (or less) away from her ultimate goal, she can hardly believe it, she says.
“It feels amazing to almost be free, almost unreal,” Latham told Lending Tree. She also noted she can’t wait for the day she is finally debt-free. From that day forward, all her money will be hers to save and invest instead of heading straight to Sallie Mae.
In this guide, we’ll show you how you, too, can become debt-free this year.
Table of Contents
5 essential steps to eliminate debt
Here are some steps you should absolutely take along the way.
Step 1: Make a specific goal.
One of the most important steps to getting out of debt is committing to the cause and a plan.
You can’t make a goal before you get real with yourself about how much you really owe. Pick a relaxing spot at home and sit down and set to work lining up each and every debt you owe. It will likely feel overwhelming, but it’s important not to let the big number scare you away from taking action.
“By setting goals and creating a plan to get there, you are creating a roadmap to success,” Brandt said. Without goals, however, life will always get in the way.
Your goals may be small at first, like paying off the credit card with the lowest balance first in order to build up momentum. But the key is to create goals and stick to them, building good habits along the way.
If you’re married, “you need to get your spouse on board for your plan to work,” said Brandt. Once everyone has committed to the process, you can sit down and create a specific plan based on what you owe.
Step 2: Be strategic in how you approach each debt.
Dedicating yourself to paying off debt is a smart first move, but the next step requires some strategy. To become debt-free, you have to figure out which debts you have and the order you need to tackle them.
Start by creating a list of all your debts, including the amount you owe, your monthly payment and your interest rate or APR. From there, you can choose to tackle your debts in a few different ways:
Option 1: Pay off highest interest debts first. The mathematically optimal solution — also known as the debt avalanche method — is to pay off higher interest debts first, says Natalie Bacon, Ohio-based financial adviser.
That means if you have an auto loan at 4%, a home equity loan at 8% and a credit card at 22%, you should tackle the credit debt first before moving onto the others. That doesn’t mean you stop making payments on your HEL or car note. You continue making minimum required payments on your other debts while throwing every last available dime you have toward the first debt.
“You will save the most money this way because you’ll pay off the highest interest rate loans first,” she said.
Option 2: Pay off smallest balances first. The debt snowball method works similarly but involves paying off the smallest debt balances first — regardless of their interest rate.
Using this method, you would order debts from smallest to largest. You’d pay the minimum payment on all your debts and put the rest of your money toward your smallest debt first.
This strategy isn’t about saving the most money over time. But it works because it helps build momentum and keep you motivated by scoring smaller wins early on in your debt payoff process.
“This will give you psychological gains because you will be excited to see your loans repaid,” said Bacon.
Latham says she chose this method when paying off her student loans and credit card bills, and that it suited her personality well.
“I’m the kind of person who needs small wins to keep them motivated,” said Latham. In that respect, the debt snowball method was ideal.
Option 3: Old debt vs. new debt. If you have old debts in collections and new debts piling up, you may want to prioritize paying off your new debts first, says Thomas Nitzsche, financial educator and credit counselor at Money Management International.
If you have the ability to make payments on your debts and your credit is still important to you, you should focus on your newer debts first, he says. From there, you can focus some of your efforts on old debts – or debts in collections.
Why? Because older debts have done their damage to your credit already. You’ve still got a chance to keep those new debts from dragging your score down, too.
Once your newer debts are stabilized and you’re making steady payments, you should start to save up money to address accounts that are already in collections.
With those accounts, consider asking your lenders to put you on a payment plan or settle your debt for a lower amount.
Paying off debt vs. saving for emergencies. Often you hear experts tell folks to save for a rainy day and pay down debt all in the same breath. But which comes first?
Brandt says that in his role as a financial adviser, he tells clients to create a savings cushion at the beginning of their journey out of debt. It may seem counterintuitive. Why put money away when you’ve got debt that you could be whittling down?
Hear him out: “If you spend all of your disposable income toward your debts, then the smallest emergency could kill your momentum,” he said. “A starter $1,000 fund is a great place to start.” That should be enough to cover most minor emergencies.
So yes, you should absolutely set aside some cash for savings as you prioritize which debts to pay off first. Even if it’s only $100 per month you can save, you’ll be better off, says Brandt.
Step 3: Make room for debt repayment in your budget.
Part of the struggle with paying off debt is the fact you’re already struggling to keep up with minimum payments. How do you find extra money when you barely have enough to begin with?
While it may not be easy, the key here is finding ways to reduce your daily spending so you can free up cash to repay debt. Some strategies to consider include:
Revert back to the “poor college” lifestyle.
Latham says one of the best things she did when she starting paying off debt is pretending she was still on a college budget. “The fewer luxuries you have, the faster you’ll be able to pay down debt,” she said.
When you graduate college, it’s easy to convince yourself you need a new car or a fancy apartment, she says. But these things cost money. The more money that you’re allocating to these nice things each month, the less money you’re going to have to put toward your debt.
Latham suggests moving back home with your parents if you can – or getting roommates that can help with rent. If you’re a parent with adult children at home, consider charging them a reasonable amount of rent.
Also, try to avoid upgrading your lifestyle in any way if you can. The purchases you don’t make will add up.
Stop dining out.
Brandt says that dining out and food spending are huge budget busters that most people in debt need to overcome. If you’re trying to pay off debt, you shouldn’t see the inside of a restaurant, he says.
Not only should you dine out less, but make sure to watch your food spending at the grocery store. Try planning out meals before you hit the store to cut down on the ingredients you buy. Eat leftovers to reduce food waste and buy mostly what’s on sale, and you could see a big difference in your bill.
Too extreme? Treat yourself to a meal out once a month until you’re debt-free.
Find ways to boost your income.
You can only cut expenses so far. At a certain point, you’ve got to look for new ways to bring in more income. Latham says one factor that really helped her was finding ways to make extra income. “Even if it’s just an extra $300 per month, that’s $300 extra you can use toward your debt,” she said.
Also, don’t care what people think. Latham says that people can be judgmental when they see you working all the time, but that’s only because they don’t understand your goals.
“People can say what they want, but you will be reaching your money goals faster,” added Latham.
Slash your optional spending.
While some bills like rent and utilities aren’t negotiable, Brandt says that everything else should be on the table. Where you spend your money is what your priorities are, he says. So, if your priority is paying off debt, your spending should show it.
“Everything in your budget should be up for grabs,” he said. “Trim back your data plan, cut cable television, and cancel all your subscriptions.”
It might help to track your spending for a few weeks to see where your money is going. Or, break out your last few months’ banks statements so you can tally up all the money you spent and where. From there, look for areas to cut and start slashing any “extras” you can live without.
And if that sounds awful, remember that sacrifice isn’t forever. “When you’re debt-free, you probably won’t even remember the things you had to say no to,” said Latham. “But you will remember not having to log in and pay another payment to your student loans.”
Consider refinancing some debts.
In some situations, it may be possible to refinance or consolidate certain debts to save money on interest and free up extra cash to pay toward principal. If you have high-interest credit card debt, for example, you could consider doing a balance transfer to a 0% intro APR credit card to get no interest for 12 to 18 months.
This strategy would help you save big money on interest. However, it will also help you pay off debt faster since your entire payment will go toward the principal of your balance as long as your card’s 0% APR offer lasts.
Step 4: Understand your options for each type of debt.
But, what if you’re falling behind on any of your debts? While you map out your debt payoff strategy, consider these strategies if you’re lagging:
If your debt struggle has you falling behind on mortgage payments, this is a situation you’ll want to rectify right away. If you don’t get up-to-date with your mortgage payments, you face the possibility of losing your home. Here are some ways to get back on track.
- Talk to your lender. Don’t put your head in the sand. Contact your loan servicer as soon as you start having issues making your payments. Your lender may be willing to set up a payment plan or have some other options for you to consider.
- Refinance your home. If your mortgage payment is difficult to meet and you have decent credit, you may be able to go for a mortgage refi. You could get a loan with a longer repayment term, which would spread out your payments and make them smaller. Of course, you’ll pay more in the long run (longer loan term = more time for interest to accrue) but it could give you the breathing room you need. Make sure to speak with a qualified lender to see if refinancing might be a viable and fruitful option.
- Apply for a loan modification. You may qualify for a loan modification under the Making Home Affordable Modification Program if you got your mortgage before Jan. 1, 2009, you owe less than $729,750 on your mortgage and it’s your primary residence. Your payment on your mortgage must also be less than 31% of your gross income, and you have to be facing a financial hardship.
- Forbearance. Ask if your lender or loan servicer offers forbearance, which is a break in time when you’re not required to make monthly payments. At the end of that time, you’ll be required to make monthly payments and additional catch-up payments, however. For that reason, forbearance isn’t a good option if you’re in a home you can’t afford.
- Sell your home and downgrade. Selling your home is an option if you can’t afford to keep up with monthly payments. If you owe more than your home is worth, you may even qualify for a short sale – a type of sale where the bank accepts less than the mortgage amount for the home. From there, you could downsize to a home you can afford. Your credit will be bruised, but you will have a better shot at tackling other debts if your housing expenses are lower.
If you’re falling behind on car payments, you have several options to consider. While some options let you keep your car, others require you to give it up. Only you know whether each of these options will work for you based on your transportation needs and lifestyle.
- Refinance your car loan. If your auto loan is at a high-interest rate and your credit score is solid, it may be possible to refinance your car to get a better interest rate and lower monthly payment. You may also be able to lower your monthly payment by extending your repayment timeline. Speak with a lender or get a refinancing quote online to see if a new auto loan may truly leave you better off.
- Sell your car yourself or let it be repossessed. If you truly can’t afford your car, Brandt says to let your loan servicer repossess it. While this will hurt your credit, you’ll at least be out from under the huge burden of a car loan, he says. You could also sell it and use the proceed to pay off as much of your loan as possible. For your next car, buy an older model and try to save up the cash ahead of time.
- Pick up a car-related side hustle. If you’re struggling to keep up with auto payments, why not make your car work for you? Brandt says you should consider picking up an auto-related side hustle such as driving for Uber or Lyft or delivering groceries with Instacart. If you can earn enough to cover your payment, you’ll be in good shape, he says.
Credit card debt
Credit card debt may be one of the easiest types of debt to rack up, but high-interest rates and the fact you can keep on charging purchases make it especially hard to pay off. If you’re behind on your credit card payments, there are several steps you can consider:
- Negotiate with your creditors. It may be possible to negotiate with your creditors to get on a payment plan. Lenders usually offer a window of opportunity to customers who’ve fallen behind on payments to work out a payment plan. You might even get late payment fees removed if you act quickly enough to get your account current. If your debt is severely delinquent and has been sent to collections or charged off, it might be time to negotiate a settlement.
- Negotiate a settlement. If you’re more than three months behind on your credit card bills, you need to take a different approach and negotiate a settlement. “After the first 30 days in collections, the damage to the credit report is done and it may be more viable to save up money and offer the collection agency an amount less than the total owed,” Brandt said. He says “save up” because settlements typically must be paid in one lump sum. You may owe taxes on forgiven or settled debts, so keep that in mind.
- Debt consolidation. If you’re falling behind on credit card bills or are just tired of juggling too many, it may be advantageous to consolidate your debts with a personal loan or a balance transfer. In both cases, you may qualify for a lower interest rate and get the peace of mind of having just one monthly payment to handle.
If you’re struggling to keep up with medical debt, you may need to take a different approach than you would with other types of debt. If you have large sums of medical debt especially, it’s crucial to make sure you’re on a repayment plan that is realistic enough to work but aggressive enough to eventually let you become debt-free.
Before you deal with medical debt, make sure to get organized and have a list of each bill, how much you owe and to whom. From there, it will be a lot easier to attack your debts once and for all.
- Negotiate a payment plan. First, read our guide on negotiating medical debt. Dealing with medical debt is a lot like dealing with a bad toothache – the longer you delay dealing with the problem, the worse things get. “You should be in conversation with the doctor or hospital’s office staff as soon as you realize that your finances will not meet the bills being generated,” said Jerry Ashton, co-founder of nonprofit RIP Medical Debt, which raises funds to help purchase and pay off consumer medical debts. Be sure that every bill is correct. Dispute as appropriate – and especially if a bill involves “out-of-network” work that was done. “Once you have settled on exactly what is owed, negotiate for the lowest possible payment you can make – and be sure that you can keep that agreement,” said Ashton.
- Ask for financial assistance. Most hospitals offer financial assistance in the form of charity care for people who meet certain income requirements. Craig Antico, the founder of RIP Medical Debt, also says that most hospitals do not charge patients that make under two times the poverty level guidelines. Antico says to see where your income falls with the Federal Poverty Level (FPL) in terms of your family size, then call your providers and ask for help. “The most important thing to do is call the provider after you determine if you qualify for their financial assistance,” said Antico. “Have your last year’s tax returns and current pay stubs.”
- Crowdfunding has become a major source of help for people with medical bills. However, asking people you know for financial help via sites like GoFundMe.com has become rather controversial. First, it’s important to note that crowdfunding websites may charge a fee. Also, crowdfunding campaigns don’t always do that well – so never count on this type of help.
- Bankruptcy – Ashton says that bankruptcy is the least pleasant way to deal with medical debt, but can often be practical. Unfortunately, he says many people do not even have the funds to go through the bankruptcy process because they may be required to meet income requirements. If you do choose to pursue bankruptcy, make sure to do so only as a last option – and only if no other option is feasible.
Student loan debt
Considering the fact Americans owed more than $1.3 trillion dollars in student loans by the end of June 2017, it’s not surprising just how many people struggle to keep up. Fortunately, there are an array of options to consider if you’re behind on federal or private student loans.
Federal student loans:
- Income-driven repayment plans. These federal plans let you pay a lower monthly payment that is based on what the government considers your “discretionary income.” Income guidelines apply. However, if you stick with the plan for the long run, the unpaid balances of your loans can be forgiven after 20 to 25 years.
- Loan forgiveness programs. Loan forgiveness plans are available to students who work in certain fields and meet other qualifications. With Public Service Loan Forgiveness (PSLF), for example, you may have your loans forgiven after ten years of timely monthly payments if you work full time in a qualified public service position. Teachers, doctors, and other professionals may also qualify for their own loan forgiveness programs. Make sure to research options for your field before moving forward.
- Forbearance or deferment. Both forbearance and deferment let you pause payments on your federal loans for a limited length of time. The main difference between the two is the fact that your interest is subsidized by the government with deferment, whereas your loans continue accruing interest during forbearance. To qualify for deferment or forbearance, you must have certain types of student loans and meet other eligibility requirements.
- Direct Loan Consolidation. A Direct Loan Consolidation lets you consolidate qualified student loans into a single new loan with one monthly payment. Consolidation can simplify your debt payoff plan by reducing the number of payments you make each month down to one. However, you can also lower your monthly payment since you can extend your repayment timeline up to thirty years.
- Refinancing with a private lender. Just know that you’ll forfeit federal protections, such as access to income-driven repayment plans. Research student loan refi options
Private student loans:
- Refinancing student loans may be a good option if you can qualify for a loan with a lower interest rate and better terms. You may also reduce your monthly payment by extending your repayment timeline, although you’ll pay more interest the longer you repay your loans.
- Working with lenders. Options are often limited for borrowers struggling with their payments on private student loans, says student loan advocate Adam S. Minsky, an attorney who focuses his practice on helping borrowers with student loans. Borrowers can use a forbearance to temporarily postpone payments, although this will likely be for a very limited period of time, says Minsky. “Some private lenders offer temporary loan modifications to reduce payments for a limited period of time as well.” If you’re struggling to keep up with your payments, your best bet is calling your lender to see what options are available.
- Bankruptcy. It’s very difficult to get student debt discharged in bankruptcy. “It is not impossible to discharge private student loans in bankruptcy, but can be very difficult because borrowers must prove undue hardship,” said Minsky. Unfortunately, this standard is very hard standard to prove and requires something called an “adversary proceeding” in bankruptcy court. Most of the time, you cannot discharge your student loans in bankruptcy and need to find a way to pay them off.
The worst thing you can do is ignore your tax debt. And filing an extension will not give you additional time to pay your tax debt either. It simply gives you more time to file your taxes.
If you are struggling to keep up with tax debts you owe, the Internal Revenue Service (IRS) offers several good options:
- Installment agreement. An installment agreement may be available to people who need several months or years to repay their tax debt. “The program allows people to make smaller monthly payments until the entire debt is satisfied,” notes the FTC. Taxpayers who owe less than $50,000 can even apply for an installment agreement online.
- Offer in Compromise – The IRS may let you settle your tax debt in one fell swoop with an Offer in Compromise, although this option is typically only available when other options haven’t worked. Typically, you need a tax professional to help you apply, notes the FTC.
- State tax-relief programs. Some states offer tax-relief programs that can forgive penalties or interest on owed tax amounts. They state you should check with your state comptroller for more information.
- Watch out for tax settlement scams: The FTC warns that consumers should be wary of any company that promises to settle their tax debt. Claims they can negotiate your debt down or eliminate it are often scams, they say.
Step 5: Set yourself up for success.
Getting out of debt isn’t easy; it’s hard. That’s why so many people languish in debt for years before they take steps to dig their way out. The good news is, the process can be made easier if you set yourself up for success in the beginning. By creating an environment where temptation is limited and you have proper support, you give yourself a better shot at reaching your goals.
As you continue forward on your path to debt freedom, consider these tips that can give you a leg up:
- Set up automatic payments. Making your finances automatic can help you stay on track. Set up automatic deposits into savings or automatic payments on your debts, and you’ll set yourself up for success.
- Have weekly money meetings. Sit down with your spouse, partner or family to discuss your financial progress every week. When you discuss your situation, you open lines of communication and make sure everyone stays on the same page.
- Use apps. Apps like Personal Capital can let you track your net worth and debt payoff for free, while an app like Mint can help you track your spending and goals. “Using apps can help you stay on track when you don’t have time to keep up with everything manually,” said Brandt.
- Focus on your “why.” Bacon says knowing your “why” can help you stay on track toward success. “Have a clear reason for why you’re getting out of debt,” she said. “Ask yourself what it makes possible for your financial future.” If you’re paying off debt because you want to save for a vacation, keep your eye on the prize by focusing on your travel goals, for example. If you’re just sick and tired of monthly payments, remembering your pain daily can help you stay focused. At the end of the day, if you focus on your reason for working your way out of debt, you’re more likely to keep your momentum.
- Educate yourself on personal finance. Bacon, who has paid off more than $100,000 in student loans herself, also suggests listening to personal finance podcasts or reading books to stay focused on your goals. “During your commute is a great time to listen to a money podcast,” said Bacon. “This will put your mind in the right mindset for debt repayment.”
Knowing when to file bankruptcy.
While it may be ideal to pay down all your debt yourself, there are times when bankruptcy is a more realistic option. Perhaps you have tens of thousands or hundreds of thousands of credit card debt or medical debts to pay off, and there’s no feasible way to do it. In that case, filing bankruptcy could be the best option you have.
Types of bankruptcy to consider include:
- Chapter 7 Bankruptcy takes place when the courts gather and sell a debtor’s property in order to settle their debts. All debts will be erased once the process is complete. A debtor may be able to keep certain “exempt” property, however.
- Chapter 13 Bankruptcy provides a negotiation of debts for individuals with regular income. Those who file for Chapter 13 may be able to keep their property and repay part of their debts over time, usually three to five years.
Since any type of bankruptcy will have very negative effects on your credit score, it’s important to pursue this option as a last resort – and only after weighing the pros and cons of other options. Also, keep in mind that you likely need professional advice to decide if bankruptcy is ideal for you – and which type of bankruptcy to pursue. Before you file Chapter 7 or Chapter 13 bankruptcy, make sure to speak with a qualified attorney who deals with bankruptcy law.
Debt relief firms – what to watch out for.
On a final note about getting out of debt, it’s important to do some research before relying on a third party for help. There are numerous companies that promise “debt relief” or even “debt settlement,” but there are times when these firms do more harm than good.
The FTC suggests working out a payment plan with your creditors on your own before seeking third-party help. And even then, there are plenty of pitfalls to watch out for:
- Check debt relief firms background and read reviews. Before you do business with any debt relief service, ask your state attorney general and local consumer protection agency if they’ve had any complaints. Search for reviews online as well.
- Read the fine print. Before you use a debt relief service, find out exactly what they offer, how much it costs and how long it takes to get the results they promise.
- Watch out for fees. The FTC warns that many firms, and even those that say they are “not-for-profit” charge high fees that they may hide. Some credit counseling firms also urge their clients to make voluntary donations, notes the FTC.
- Know the risks of debt settlement. Debt settlement is a process where a for-profit company instructs you to save money so you can settle your debts for less than you owe. However, this process comes with many risks. Not only do some debt settlement companies urge you to quit making monthly payments on your debt, but they require a long-term commitment to saving money for debt settlement. The FTC notes that many people drop out of these plans before they reach their goals. Also, keep in mind that your creditors aren’t required to negotiate your debts. So, there’s a chance you could go through all the hassle of saving money for debt settlement and not get any results. Last but not least, stopping payments on your debt can cause further damage to your credit score.
Final word: Don’t wait till you’re “ready” to start paying down debt.
If you wait until everything in your life lines up perfectly before you start tackling your debt, you may never start.
Latham’s story is proof. Not only did it take her nearly seven months to find a job after college graduation, but she only earned $30,000 a year at first. Then, five months after she was hired, she was let go. But she didn’t give up. She simply altered her plan.
“I had to put my student loans in deferment until my next job,” she said. Soon after, she also lost her dad, who passed away.
“Losing a job isn’t as tough as losing someone you love,” said Latham, adding that “you can always make more money.”