Getting Out Of Debt
How to Create a Debt Elimination Plan
Most of us know how credit card companies can reel us in with low interest rates or good deals, as well as how easy it can be to get caught up in the moment and take on debt despite planning to pay off our cards in full every month.
If you’ve developed a habit of splurging on purchases one too many times (it happens to even the best of us), you may want to explore a debt-elimination program to get you back on track. Here are some debt elimination strategies to help you rein in any mounting debt as you work towards better financial stability.
Round up your debts
First things first, you need to know what you're facing when developing a real debt elimination plan you can stick to, and that starts with looking at your current debts.
Whether it’s in an Excel spreadsheet, a budgeting app, or simply a notebook you keep handy, list out all your debts, including the balances, minimums due, and interest rates. Having the basics ready at a glance can come in handy later when you're deciding which debt to pay off first.
Lost track of some of your debts? Look at your bank statements to see where your money goes each month. Or, pull your free credit report to get an overview of all your accounts with a balance owed.
Grab info for the rest of your expenses
Whether your bank account is thriving or you barely have enough to buy a burrito at the gas station, confronting your spending and taking a hard look at your expenses can be helpful. Reviewing your bank statements can again be a big help here.
With those detailed records in hand, you can start to plan a budget with categories like housing, loan payments, credit cards, clothes, groceries, and dining out. What does a budget have to do with debt elimination? It helps you put more money toward paying off those high-interest debts.
Your DIY financial analysis can also help you confront your spending habits and look for ways to cut back and save money.
Maybe you give in to the happy hour invitations after work a little too often, or your grocery budget goes out the window when you opt to order in a few nights a week. Being aware of those patterns can help you start changing your habits and freeing up more money for your debt-elimination program.
Find the right budgeting method
Listen, no one wants to cut back on spending or tally where their money is going with each swipe of the card. But if you don't budget, you may not be able to get your spending or debt under control.
Budgeting is a little easier when you find a method that works for you. It's still not fun to say no to those splurge purchases that don't fit your budget, but you might be less likely to rely on your credit card and rack up further debt if you’ve at least laid the groundwork for responsible spending.
Here are some popular budgeting techniques that could help you get rolling with your debt-elimination program.
The 50/30/20 budget method helps you divide your money without getting too specific. The idea is that 50% of your paycheck goes to your necessities. That would be things like housing, car payments, and groceries.
The next 30% is yours to spend on your wants. This could include a gym membership, streaming services, entertainment, and clothes.
Finally, the other 20% goes to debt repayment. You might use this portion to pay down your credit cards faster as part of your debt reduction plan.
If you're on a tight budget and have a lot of debt, this approach might not work for you. Sometimes, you just don't have enough income to spend 30% on your wants. Your necessities might take up more than 50% of your paycheck or you might want to put more toward your debt.
You could adjust the percentages based on your situation. But if that doesn't work, a different budgeting approach could help you kick your debt to the curb.
Are you a numbers person? Do you need to know where every last cent goes? A zero-based budget could be right for you. It's also ideal for people who tend to overspend and need more structure.
For a zero-based budget, it’s a plan where every last dollar you receive goes to take your account to zero. You allocate your entire paycheck to specific expenses.
You might not end up spending it all. Maybe you hit the coupons and clearance aisles hard this week and only spent $125 of your $200 grocery budget. But every dollar in your paycheck will be assigned to a certain expense.
This method takes a lot more planning and tracking. Tempted to splurge on a fancy dinner at a new high-end steakhouse? Better check that budget first to make sure you still have funds in your dining-out category.
If the idea of budgeting down to $0 stresses you out, you might feel better knowing you can get a Varo Advance as a safety net.1 It's a cheap, fast way to get $20 to $250 if your $0 budget turns into a negative balance.
Pay yourself first
If you don't like the idea of a strict budget with categories for every penny you spend, you might like the pay-yourself-first method of handling your money. This method doesn't ask you to break down your entire paycheck into separate categories. Every time you get paid, your first priority is money for savings.
That could be your retirement funds, savings accounts, emergency funds—whatever savings goals are a top priority for you. A high yield Varo Savings Account can help you make the most of your savings with up to 5.00% Annual Percentage Yield (APY) on your balance.2
Money that doesn't go into your savings is up for grabs, but remember, you'll still have bills to pay out using that money.
Envelope systems/cash stuffing
Maybe you've tried to keep your spending under control, but you feel like you don’t trust yourself with the plastic in your wallet. It's not just you. Debit and credit cards make it very easy to spend more than you planned. Switching to a primarily cash-based method can be a better approach for some when striving for debt elimination.
This method is a little like the zero-based budget in that you divide your income into different categories. Each category gets a certain amount of your paycheck. You might set aside $100 for entertainment and $150 for groceries.
You withdraw however much money you're allocating to those categories. Then, you literally stuff the cash into separate envelopes, one for each spending category. When the cash for that category is gone, you're done spending on those things until your next payday.
Spending with cash can help you control your spending because you have a limit based on how much cash you have and you see it leaving your hands. It's a visual reminder that you're handing over your cold, hard-earned cash rather than charging it on a card and worrying about paying it off later.
Choose your debt elimination strategy
Budgeting can help you determine how much money you can put towards your debt and help you find ways to stop excess spending. However, budgeting is just the first step towards building a debt elimination strategy.
The financial world takes a somewhat “chilly” approach to two major debt elimination strategies—avalanche and snowball methods are two of the most common. With both methods, you choose one debt to prioritize and all extra money goes toward that account. For the rest, you'll only pay the minimum amount due.
Both options may help you slay your debt, but one might make more sense to you based on your situation.
The avalanche approach
The debt that gets prioritized in the avalanche method is the one with the highest interest rate. Remember that list of debts you created? Grab that list and pinpoint the account with the biggest interest rate.
Any extra money that you have in your budget goes toward that high-interest debt. The goal of this method is to save you money on interest paid over the course of your debt-elimination program.
The drawback to this method is that you might not feel like it's working fast enough. Your highest-interest debt could also have a higher balance. Even when you're putting all your extra money toward it, the account may take a while to pay off.
Yet, if you stick with it and pay it down aggressively, you can end up paying less interest overall. Once you reach a $0 balance on that account, go back to your list of debts to find the next highest interest rate. Repeat the process with that account, putting any extra funds toward it until you pay it off.
Rinse and repeat until all your debts are gone.
The snowball approach
Need to see fast progress to keep you motivated? You might be more of a snowball person.
This method prioritizes the account with the lowest balance. The idea is that you can pay it off quickly and eliminate a payment. Put all your extra money toward that account until you eliminate it.
When you finish paying off your lowest-balance account, you can put the minimum payment for it plus all the extra money in your budget toward the account with the next lowest balance. Continue until everything is paid.
Using the snowball approach can give you a sense of accomplishment, as you can see the first balance drop quickly and eventually cut down on the number of balances you have.
Some people don't like the idea of having several individual debt payments and covering all the minimum payments can spread your budget thin. Plus, the interest rates aren't always great on credit cards, especially if you've fallen behind on your payments.
Consolidating your debt into one payment is another strategy for reducing your debt. Two main methods of doing this are transferring to a credit card with a lower or 0% interest rate, or taking out a loan to pay off the credit cards.
Instead of tracking individual debts and prioritizing which one to pay next, you make one large payment each month. To pay your debt off as fast as possible, put any extra money toward that balance.
The key to making this method work is not charging anything new to the credit cards once you pay off the balances. You could find yourself in serious financial trouble if you start to quickly charge them up again, as you now have new minimum payments on old accounts plus the payments for the consolidation loan or credit card.
Make your debt-elimination program successful
There's no quick fix when it comes to getting rid of debt. Creating a debt-elimination program that works for your spending habits and budget can help you stay on track.
If your credit score takes a hit because of your debt situation, consider the Varo Believe Card that’s designed to help you build or repair your credit, regardless of your credit history.3
Racking up significant debt happens to even the most financially responsible of us, often for reasons that may be out of our control. Fortunately, by carefully budgeting, taking a hard look at unnecessary expenses, and finding a debt elimination plan that works for you, you can kickstart your journey towards more stable financial footing.
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