Before proceeding with specific debt repayment methods, it is necessary to establish a solid financial foundation. The first step is to create a budget.
A budget helps you understand your income, expenses and how much you can afford to pay off debt.
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Let’s look at a real example:
Meet Sarah: She’s a recent college graduate with $30,000 in student loans. To create a budget, Sarah starts by reporting her monthly income, which is $3,000 from her job. After listing her basic expenses, such as rent, utilities and groceries, she realizes that she has $1,500 left each month. Sarah decides to use $800 of this surplus to pay off her student loan.
It may be hard at first to put all your extra capital into debt, but trust me it’s worth it.
Debt Avalanche Method
The debt avalanche method is a popular approach to paying off debt quickly. With this strategy, you focus on paying off the debt with the highest interest rate first. Once that debt is paid off, you move on to the next debt with a higher interest rate.
Let’s see how Sarah applies this method:
Sarah has three student loans with interest rates of 6%, 4.5%, and 3%. He prioritizes the loan with an interest rate of 6%.
After making her minimum payments on the other loans, she directs the extra $800 to the loan with the highest interest rate until it’s paid off.
This method can save her a significant amount of money in interest payments over time.
The debt avalanche method
Another popular strategy is the debt avalanche method. In this approach, you focus on paying off the smaller debt first, regardless of the interest rate. Once that debt is eliminated, you move on to the next smaller debt.
Here’s how it works for Sarah:
Sarah has three student loans with balances of $10,000, $15,000, and $5,000. Instead of prioritizing the higher interest rate, he starts with the $5,000 loan.
He has the extra $800 on this loan and is paying it off quickly. The sense of accomplishment from eliminating the smaller debt motivates her to tackle the larger ones.
This method can provide a psychological boost, even if it doesn’t save as much interest as the debt avalanche method.
Debt Consolidation
Debt consolidation is a strategy that involves combining multiple debts into a single loan with a lower interest rate. This can simplify your monthly payments and potentially lower the total interest you pay.
Sarah is considering this approach for her student loans:
Sarah qualifies for a debt consolidation loan with an interest rate of 4%, which is lower than her current student loan rates. By consolidating her $30,000 in student loans, she saves money on interest and simplifies her monthly payments.
This can be an effective strategy if you can secure a lower interest rate.
Increase income to accelerate debt repayment
While budgeting and smart debt repayment strategies are essential, increasing your income can greatly speed up the process.
Many people take on part-time jobs, freelance work or side gigs to generate extra income.
Sarah decides to work part-time as a freelance writer, earning an extra $500 a month.
That extra income goes toward her student loans, helping her pay off the debt faster.
