Best Ways to Get Out of Debt

Tens of millions of Americans need debt relief. Everyone's story is different, but what they have in common is a goal: to ease a debt burden weighing on their finances and lifestyle. 

Perhaps you had a medical emergency. Or a difficult divorce upset your finances. Or maybe you developed habits over time that led you to spend more money than you had coming in. 

However you got here, there are multiple pathways out of debt trouble. Take a look at the best ways to get rid of debt, and consider which fits your needs. Better yet, think about whether trying more than one approach could get you debt-free faster. 

Best Ways to Get Out of Debt: A 7-Step Plan

Do you want to get rid of your debt fast? You already know that’s easier said than done. A problem that may have been building for years won’t be solved overnight. 

Still, you’re the boss of your bucks. Break up the job into a series of separate, bite-sized steps.

You can approach the best ways to get out of debt as a seven-step plan. Start with the first step, and then move on to the next one. You may not even need all seven.

By taking a series of steps in the right direction, you’ll soon notice progress. Each step can make your debt burden a little lighter. Each win encourages you to keep up the good work. 

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Step 1: Financial and Lifestyle Changes 

The first step is to keep the hole you’re in from getting any deeper. Figure out why you're in debt, and what you need to do to stop taking on new debt. 

Maybe your debt was due to a one-time setback. On the other hand, maybe borrowing has become a routine part of your lifestyle. 

In either case, better spending habits could help you stop adding to the problem. Even if your debt was caused by a one-time setback, you’ll still need to come up with the money to repay it.

Of course, if the problem is that borrowing money has become necessary to support your regular lifestyle, you need to change that lifestyle. Borrowing is best when it’s for something that delivers lasting value, like transportation, a home, or an education.  

If the debt lasts longer than what you’re buying, don’t borrow to pay for it. 

This doesn’t just mean loans. Most often, borrowing takes place without people thinking much about it because it's so easy to pay by credit card. 

In fact, a study of consumer payment habits by the Federal Reserve Bank of Atlanta found that credit cards have become the most common payment method. The average American uses a credit card 17 times a month. With such a frequent habit, it's easy to use credit cards without thinking first about how you’ll pay off the debt. 

Routine use of a credit card becomes a problem if you regularly carry a balance. Carrying credit card balances means you’ve turned a short-term purchase into long-term debt. That debt almost always carries a high interest rate, which means you’re paying a lot more for your purchases than the sticker price.

Breaking the credit card habit depends on creating a budget that allows you to live within your means. 

Step 2: Budget for a Debt-Free Future

A budget that points you to a debt-free future has to do two things:

• Get you from month to month without any new borrowing

• Free up money to pay down debt faster

To start, get in the habit of saving your receipts. Go through a month’s worth and separate the necessary purchases from those that weren't. 

List the dollar amount of the necessary purchases that are likely to occur repeatedly. Add to that list any bills you have to pay each month, including payments on existing debt. Total up the list, and this should be your budget for monthly expenses. 

Now compare that amount to your regular take-home income. If your expenses exceed that number, you need to cut costs or find more income. The goal is to get your cash flow to where there’s more money coming in than going out. 

Once you get your budget down under your take-home pay, figure out how much money you have to spare each month. Devote most of this amount to paying down debt. 

Too often, people only pay down debt with whatever money happens to be left over after they’re done spending. That means there may not be anything available for debt reduction, and balances will creep up. Make debt reduction a budget priority so you can plan on having money available to pay down debt. Otherwise, it's just not likely to happen.

Step 3: Step on the Gas and Knock Down Your Debt

Once you’ve allocated more money in your budget for paying off debt, it’s time to put the pedal to the metal. These tips can help you get the most bang for your buck when you’re paying down debt.

Knock out your most expensive debts first with a debt avalanche

If you have multiple debts, take out the toughest one first with a debt avalanche. This is a method of attacking your most damaging debt first—the one with the highest interest rate.

Start by making a list of all your debts, along with their balances and interest rates. Rank them in order from the highest interest rate to the lowest. 

Make the minimum payments on your credit cards and other debts, except the one with the highest rate. For that debt, throw as much cash as you can on top of the minimum payment until it's gone. Then, go back to your list and find the balance that now has the highest rate and focus on that one. 

By eliminating high-interest debts first, you could save on interest charges. That's why it’s called an avalanche—as more of each payment goes toward your balances, your debt repayment gathers more force.

A debt snowball can allow you to celebrate small wins

A different method for prioritizing your debt payments is called the debt snowball, which aims to eliminate your smallest debt first.

Why? Because the smallest debt is the one you can eliminate most quickly. That simplifies your bill payments, and may give you the rewarding feeling of making progress. 

In the long run, the avalanche method could get you out of debt faster (typically zero to two months faster, compared to the snowball). If you want to get rid of one monthly bill and gain a  clear feeling of making progress, you may prefer the snowball method. 

Increase your payments when you can (every little bit helps)

Your budget isn’t a set-it-and-forget it exercise. Keep an eye on it, and continue to look for ways of shaving a few dollars off your spending every month. 

Doing this will help keep your spending from creeping back up, and you may find some extra money to put toward debt reduction. 

Slash your balances with lump-sum payments

When you get a financial windfall, resist the temptation to spend it all on something big. Instead, splurge on your future self by making a bigger dent in your debt.

Do this when you get a bonus, a tax refund, an insurance payout, a lawsuit settlement, or any other one-time chunk of change. A lump-sum payment could reduce your balance, lower the total amount of interest you ultimately pay, and speed up your debt repayment journey.

In the long run, this will give you more money to spend on yourself than if you spend the money now.

Combine strategies for maximum impact

Debt payoff strategies work even better when you combine them. 

For instance, you could pay off your smallest debt for a quick win and then focus your attention on your most expensive debt. 

Also, any time lump-sum windfalls come along you can use them to supercharge your avalanche or snowball strategy. Keep up the pressure on your debt and you'll be able to watch it melt away faster.

Step 4: Avoid Payment Traps

Whatever system of debt reduction you use, there are a few payment traps you should avoid.

Manage deadlines to avoid late fees

Whether you use automatic bill payments, calendar reminders, or some other method, keep your payments on schedule. Paying attention to your deadlines can help you avoid incurring late fees that will push your debt in the wrong direction.

Use automatic payments wisely

Automatic payments can be a great tool for making sure you don't miss billing deadlines, but you can't completely take your hands off the wheel. You have to make sure the money to cover those payments is in your bank account when the time comes. Don't use automatic payments unless the amount of the payment is predictable enough for you to budget for it accurately.

Don't pay just the minimum

Don't be fooled into thinking your debt is manageable just because you can afford the minimum payments on your credit cards. Those minimums are designed to drag your debt out over a longer time and make it more expensive. 

Also, if you use your credit card at all during the month, chances are paying just the minimum will result in your balance rising rather than falling. You can use the avalanche or snowball method to decide where to direct extra payments, but your goal should always be to pay more than the minimum.

Avoid payment surcharges

You may have noticed some restaurants are adding extra charges when you use a credit or debit card. These surcharges are to cover the processing fees they pay on those transactions. What you may not know is those surcharges are even more common on certain routine bill payments, like taxes, utilities, and rent. Using bank transfers rather than a payment card can allow you to avoid those charges.

Step 5: Consider a Debt Consolidation Loan to Lower Your Rate

If you can lower the interest rate that you’re paying on debt, you could make more progress against the balance that you owe and clear your debts faster. A debt consolidation loan is one way to do that.

Debt consolidation means taking a new loan and using it to pay off multiple other debts. It could be a good move if you qualify for a new loan that has better terms than your existing debts.

Here are a few ways to consolidate.

Home equity loans

If you’re a homeowner and you have sufficient equity, you might qualify for a home equity loan to pay off your higher-interest debts. Home equity loans tend to have much lower interest rates than credit cards. There are usually fees to get a home equity loan, and of course you'll have to plan for how you'll make the payments.

Cash-out refinance loan

This is a new mortgage that replaces your current mortgage. If you opt for cash out, that means the new loan is bigger than your current mortgage balance, and you get the difference in cash. You could use that cash to pay off your other debts.

Student loan refinancing

If you have federal student loans, you might be able to consolidate them into a single loan. The interest rate will be an average of your existing interest rates, so you might not lower the cost of your debt. Also, the new loan might extend the total number of years that you’re in repayment (but you don’t have to stick with the minimum payment). There's no fee to consolidate federal student loans. 

Personal loans

Personal loans tend to have lower interest rates than credit cards. There’s usually a fee to get a personal loan. 

No matter which strategy sounds good to you, check with multiple lenders to find the best terms you can qualify for. Stick with lenders who do a soft credit check before you’re ready to apply. A soft credit check won’t hurt your credit score. Once you submit a formal application, your score could drop by a few points.

Step 6: Seek Debt Relief

Suppose you’ve tried all the steps so far, and you still can’t make your debt payments. You’ve tightened your belt, made a budget, and prioritized your debts according to their interest rates. Still, there just isn’t enough money in your budget to cover all your payments.

If that’s the case, don’t ignore the problem because it will only get worse. Instead, you need to negotiate with your lenders to find out if you can get some kind of debt relief.

Debt relief may include any or all of the following:

• Payment reductions

• Lower interest rates

• Waiver of fees and penalties

• A temporary reprieve from having to make payments

• Reduction of the amount you owe

If you can't qualify for a debt consolidation loan and can't afford your current payments, consider a debt management plan (DMP). Credit counselors can help you by consolidating your unsecured debts into a plan with a single payment. They may be able to negotiate lower interest rates, fees, and payments from your creditors. Note that a debt management plan doesn't reduce the amount that you owe.

Getting a credit card company or other creditors to reduce your balance is called debt settlement. Debt settlement is a heavy-duty solution for serious debt problems. For one thing, this will probably be the hardest to negotiate with your creditors because they would be settling for less than you owe.

Also, debt settlement affects your credit report for up to seven years and may have tax consequences. 

To work out a debt settlement, most people stop making payments to creditors. The money goes into a debt settlement fund instead. This strategy helps you come up with a lump sum to offer your creditors and shows them that you’re experiencing a hardship.

As you go through this negotiation, it helps to know your rights. The federal Consumer Financial Protection Bureau maintains resources to help you understand what debt collectors are and are not allowed to do.

Step 7: Get Debt Relief Help

Working step by step, you may be able to come up with a budget and a debt relief plan on your own and negotiate successfully with your creditors. 

However, if it gets too overwhelming, help is available.

Besides credit counselors, there are also professional debt settlement companies to consider. Debt settlement companies negotiate with creditors on your behalf. You’ll pay a fee only if your debt is successfully settled.

If you've tried all the other steps and haven't been able to conquer your debt, debt settlement may give you one more option for getting the job done. 

Staying out of Debt Trouble

Paying off debt is a terrific achievement. To make sure you can truly enjoy it, you need a plan for staying out of debt trouble in the future. 

Most people need to borrow money at some point. Just take care of when and how you do it. Here are some tips to help.

Build an emergency fund

Emergencies are bound to happen—it's just a matter of when. Keeping some cash in reserve as an emergency fund can allow you to afford these emergencies without borrowing. Once you're out of debt, take some of the money you'd been devoting towards debt payments and put it in an emergency fund. Eventually try to build it up to enough to live on for six months. 

Make saving automatic

Set up automatic transfers every payday into savings. When you get a raise, challenge yourself to keep your spending the same so you can put the extra money into savings. 

Check in on your budget regularly

Financial needs change over time, and of course, the unexpected happens every now and then. Monitor your budget at least once a month to keep your spending on track and make adjustments as needed. 

Understand needs vs. wants

Make an effort to distinguish between what you need and what you want. For instance, you may need a car, but you don’t need an expensive car. If you’ve got an expensive car payment, consider selling your car and buying a cheaper one so you can dedicate that car payment money to your debt payoff plan.

Borrow only for long-term benefits

If you've been in debt trouble, you know all too well that debt can take a long time to get out of. So, you should borrow only for things that have long-term benefits, like buying a house.

Remember your debt while you focus on the future

Never forget what you've been through to get out of debt, and how good it feels to be free of it. This will help keep you motivated to stay in control of your spending.