The MoneySense guide to debt management: How to get out of debt
If you’re like most people, you’ve probably struggled with debt at one point or another and been told to make a plan to pay it off. But what does that mean?
We’ll walk you through a simplified process, from understanding your debt to learning about the tools available to you and creating a budget, and ultimately, how to stay out of debt going forward. If you’re ready to get a handle on your finances, let’s get started.
Key takeaways
- Understand what types of debt you have and what you currently owe before making a repayment plan.
- Interest rates vary widely by the type of debt, so prioritize repaying debts that are costing you the most.
- Strategies to tackle your debt include DIY repayment, balance transfers, consolidation loans, home equity loans, and more.
- Cut back spending while paying down debt to prevent your balance from growing, and make a plan to stick to your budget so that you don’t get back into the debt cycle.
Types of debt (and why this matters)
There are a few types of debt that you should understand:
- Secured debt is backed by collateral such as a car loan or a house. If you don’t repay your debt, the lender has the option to seize the asset. It usually has lower interest rates.
- Unsecured debt is held without any collateral and is heavily based on your creditworthiness and trust that you can and will repay the debt. Most credit cards are unsecured.
- Revolving debt is open-ended, which means that as you pay down the balance, you have more credit available to use. An example of this is credit cards and lines of credit.
- Installment debt is closed-ended. You get a lump sum payment from the lender and pay it back over a certain period, usually with fixed monthly payments. Personal loans and car loans are common examples.
Before you pay off your debt, you’ve got to know what you owe. Write down or make a spreadsheet of every type of consumer debt you have—we’re talking credit cards, lines of credit, personal loans, car loans, and student loans. Don’t include secured debt, like your mortgage, in this list.
As you’re listing each debt, make a note of the type of debt/account, amount owed, interest rate, and minimum payment.
When is your debt a problem?
There are many telltale signs that your debt is becoming an issue.
Do a gut check. Are you feeling overwhelmed or stressed by the thought of your debt? Maybe you’re getting calls from collections that make your blood pressure spike whenever the phone rings.
Even if it hasn’t gotten to that point, your debt might still be a concern if you’re only making the minimum payments and your balances continue to grow, or if you have to rely on credit to buy essentials and make ends meet.
You might feel like you don’t have many options, but we’ll show you the tools you have to take control of your personal finances.
Your debt management tools
There’s no one-size-fits-all tool for paying down debt, and the right approach will depend on your unique situation. Here are some of the tools you can use to consolidate debt—and the pros and cons to consider before you move forward.
DIY
If you’re able to manage your debt without consolidation, two popular repayment strategies are the snowball method and the avalanche method.
With the snowball method, you focus on paying off your smallest debt first. Put as much money as possible toward that balance while making minimum payments on the rest. Once that debt is paid off, move on to the next-smallest, building momentum as you go.
The avalanche method targets the debt with the highest interest rate first. Pay as much as you can toward that balance while continuing minimum payments on the others. After the highest-interest debt is gone, shift your focus to the next-highest, helping you save more on interest over time.
| Pros | Cons |
|---|---|
| You have full control over how and when to pay the debts | Requires strong self-discipline |
| No setup or service fees | Progress can be slow |
| Flexibility to adjust as your situation changes | No interest-rate relief |
| Less structured, which risks missed payments |
Balance transfer
If you have multiple credit cards and are struggling to make the minimum payment on each, consider opening a balance transfer credit card. The best cards typically have a temporary 0% interest rate, which allows you to transfer existing credit card debt to the new card and have only one payment to make.
| Pros | Cons |
|---|---|
| Lower (or even 0%) interest rate | 2-5% balance transfer fees |
| Simplifies payments | Limited promo period for the lowest interest rates |
| May improve your credit utilization | Requires good credit to qualify for a card |
| May not get approved for a high enough limit to consolidate all the debt |
Canada’s best credit cards for balance transfers
Consolidation loan
A debt consolidation loan can help you merge multiple high-interest debts into one monthly payment with a lower interest rate and a fixed repayment timeline.
| Pros | Cons |
|---|---|
| One payment for everything makes budgeting easier | Requires good credit for the best loan terms |
| Potentially lower interest rate | Risk of using your cards once they’re paid off and accumulating more debt |
| Fixed repayment schedule | Longer term loan could cost more in interest |
| Possible credit score improvement | Potential fees to set up loan |
Secured loan
If you have an asset, you might qualify for a secured loan, like a home equity line of credit (HELOC). These typically have lower interest rates than consolidation loans since you’re using your asset as collateral.
You’ll typically receive funds that you can use to pay off each of your debts. If your debts total a large sum, sometimes the bank or credit union might handle the payments for you. Then, you’ll need to make repayments on the secured loan (or risk losing your asset).
| Pros | Cons |
|---|---|
| Typically the lowest interest rates | Risk of losing your asset |
| Higher borrowing limits | Risk of using your cards once they’re paid off and accumulating more debt |
| Flexible repayment terms | May have fees, such as for a house appraisal |
| Can receive guidance from bank or credit union | Application and approval process can take several weeks |
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How to get out of debt
Now that you have a handle on what you owe, you’ll use that information to create an action plan.
1. Assess your debts
Take a look at the information you gathered earlier. If you have multiple debts, you can organize the details in a few different ways, such as grouped by debt type or ranked from highest balance to lowest.
There’s no right or wrong way to assess your debts—the point is to become familiar with what you owe, how much you’re being charged, and when you’re expected to make payments.
2. Choose a payoff method
In the past, you may have haphazardly made payments and hoped for the best, but it’s time to pick a payment strategy.
| Payoff method | Best for… | Ideal when… |
|---|---|---|
| DIY snowball method | People who need quick wins and motivation | You want to make fast progress on small debts |
| DIY avalanche method | People focused on saving money by minimizing interest charges | You have high-interest debts and the discipline and patience required to start slow |
| Consolidation loan | People with good credit and multiple high-interest debts | You qualify for a low rate and want to simplify your payments |
| Secured loan or line of credit | Homeowners with large debts and home equity | You need to consolidate a large amount of debt and are comfortable leveraging the equity in your home |
3. Create a budget (and stick to it)
There are many ways to create a budget that works for you, but remember, the overall goal of a budget is to allocate spending so you’re not spending more than you’re making. Ideally, your budget includes room to pay down existing debt.
Some people find they can stay on track by using mobile apps or online budgeting programs, while others have better luck by sticking to a cardless system of payments. That’s essentially what the envelope budgeting system is.
Regardless of how you keep yourself accountable, you’ll want to follow these basic steps for creating an initial budget:
- List your total monthly income
- Calculate all of your monthly expenses (including minimum payments)
- Divide your expenses into necessities and discretionary spending
- Subtract your necessary expenses from your monthly income
- Allocate the remaining money to savings, paying down debt, and discretionary spending
How you choose to distribute your remaining funds is completely up to you, but you’ll want to prioritize paying down debt. The faster you can pay it off, the more money you free up for savings and discretionary spending down the road.
4. Prioritize your emergency fund
While paying down debt is important, we’d argue that having an emergency fund is even more important.
Why? If you don’t have an emergency fund, all it takes is one large expense you weren’t expecting to set you back into that cycle of debt.
How much? Aim to start with $1,000. This is enough to cover most unexpected expenses. Ultimately, once your debt is under control, you’ll want to keep three to six months worth of essential living expenses in your emergency fund.
Where? A high-interest savings account (HISA) is the ideal place to keep your emergency fund because it’s easily accessible and earns you some interest while it’s there.
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5. Boost your income
Increasing your income can speed up your debt payoff and ease the financial stress you’re probably feeling. Here are a few ways to do that:
- Pick up extra shifts at work or take on a part-time job
- Ask for a raise or promotion
- Pick up a side hustle, like writing, tutoring, or selling crafts or art
- Sell items you no longer need
Remember: Put all of the extra money you earn towards the debt payments. The faster you pay that off, the faster you’ll free up money for other things.
Staying out of debt
Having an emergency fund to fall back on can be a lifesaver (and prevent you from charging unplanned expenses to your credit card), but it’s just one way to stay out of debt. Here are some other habits to help you avoid falling back into the cycle:
- Create and stick to a budget. You should be able to account for all your money each month and plan your spending to stay within your means.
- Set financial goals. Having clear goals in mind can help you prioritize saving—and give you something to celebrate with when you hit your milestones.
- Use your credit wisely. Always pay your full credit card balance each month, and set up alerts and autopay to ensure you never miss a monthly payment.
- Track your spending. Once a month, review your credit card statements for errors or unnecessary spending.
- Avoid impulse purchases. Mobile shopping apps and tap payments make it easier than ever to spend money quickly. Think about your purchases before you hit “buy” and consider whether they fit your budget and priorities.
Getting out of debt takes time, but every step counts. Stick with your plan, celebrate your wins, and you’ll set yourself up for a strong financial future.
FAQs
There is no single best way to manage debt since everyone’s finances are a little different. The best way for you to get out of debt is to come up with a personalized plan that you can stick to.
Prioritize paying down debt that’s costing you the most. As you pay down debt with the highest interest rate, try to boost your income so you’re not adding to your debt load.
To get out of debt when you’re broke, dramatically cut your spending and try to secure additional sources of income. If you have a lot of debt, explore consolidation to take advantage of single monthly payments and lower interest rates.
To increase your income to pay off debt faster, consider picking up additional hours at work, starting a side hustle or gig work, or selling items you no longer need. Put all that extra money straight to debt repayment.
The post The MoneySense guide to debt management: How to get out of debt appeared first on MoneySense.
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