Figuring out how to pay off debt can be daunting. The more money you owe, the more overwhelming tackling the amount can be.
When trying to become financially free, you need to have a plan. There’s a saying that goes, “you can wander into debt, but you can’t wander out of debt.”
One plan is to pay everything off in order of interest rates. Paying off your debts in order of highest to lowest interest rates will cause you to pay the least amount of interest. When following this plan, you will focus on paying off the one with the highest interest and then making minimum payments on everything else.
“Tackling the highest rate balances first can motivate you to take charge and cross the ultimate goal of crushing all of your debt,” said Sarah M. Place, CEO of Place Trade Financial Inc.
In order to clean up your finances, the first thing you need to do is not add any more debt. It helps to create the habit of spending wisely. Cut up the credit card, don’t go buy another pair of shoes and you don’t need to go out to dinner every time a friend invites you. Now, this doesn’t mean that you can’t buy or do anything, but you should budget everything and pay for them in cash while you are getting out of debt. Paying with cash will help you not spend more then you budgeted.
Your second order of business might be to list your balances in order of highest to lowest interest rates.
Your list of debts could look like this:
- Credit card 1 – $5,000 at 13% interest
- Credit card 2 – $3,700 at 11.25% interest
- Car loan – $11,000 at 6.5% interest
- Credit card 3 – $2,500 at 5.3% interest
- Student loan – $15,000 at 3.6% interest
The first debt you will focus on paying off will be the one with the highest interest rate. In the example list above, you would pay off the credit card with the 13% interest rate first and make only minimum payments on everything else. After the first one is paid off, you will move to the one with the second highest interest rate. You keep moving down your list until all of the balances are at $0.
By focusing on paying off one at a time, it will help you stay motivated to accomplish your goal.
One of the biggest advantages of starting with the highest interest rates first is that you will end up paying less because the highest interest debts will be gone first. The quicker you pay off the highest interest debts, the slower your balance will grow.
“You slow the rate of growth on your overall debt portfolio by getting rid of the debt that was growing at the highest/fastest rate. Allowing the same amount of money to stretch farther and help you pay off lower interest rate balances faster,” said Place.
Tips to pay off debt faster and stay on track
- Have a $1,000 emergency fund for things that may come up like a flat tire or an urgent care visit.
- Eat dinner at home. Cooking at home is cheaper and healthier for you
- Pack a lunch. You can save up to a few hundred dollars a month by bringing your lunch instead of eating out.
- Get an extra job. Adding $1,000 or more a month to your income can help speed up this process.
- Shop for clothes on the clearance rack or resale shops.
- Use coupons at the supermarket. Look for coupons in ads, mailers, emails and coupons apps.
- When you do go out to eat, use a coupon or find a deal.
- Use cash. People tend to spend less if they use cash.
- Do a written budget. This will help you stay focused and organized with your money.
- Have an accountability partner. This will help you get back on track when you want to go on a shopping spree or take out a new credit card.
Paying off the highest interest rates first makes the most financial sense. If you’re the type of person that needs more motivation and quicker “wins,” you may want to look at how paying off the highest interest rates first compares to other ways of getting out of debt.
No matter how much you owe, paying everything off can be a hard journey. It’s important to stay focused and remember why you want to do this in the first place. Your reason for paying off your debt may simply be to be financially free or it may be so that you can qualify to buy a home you love. Whatever your motivation, it is important to stay focused on your reason why. The process of becoming financially free will not be fun or easy, but it is always worth it in the end.
Do you know of any other tips to help pay off debt? Comment below with your ideas.
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