Answer These 6 Questions to Find the Right Debt Payoff Plan
If you feel overwhelmed thinking about debt, you’re not alone. Nearly four in 10 Americans say they don’t feel very confident in their ability to create a plan to get out of debt, according to the Pew Research Center.
Crafting a solid plan to leave your debt in the rearview mirror takes some planning, but it doesn’t need to be particularly complicated. Like most things in life, it’s about finding the best “fit” for you.
Answer these six questions to figure out which debt plan aligns with your goals.
1. How did you end up in debt?
Before you can find a good solution, you first have to identify the problem. In this case, that means you can’t properly consider the options to get out of debt until you’ve figured out how and why you ended up there.
Maybe your debt is a result of falling behind on payments after overextending your credit, leaving you with a mountain of residual interest. Or you could have struggled to keep up with your bills after an unexpected medical emergency. The important thing is to identify the cause.
“The most common mistakes are ignoring the problem and continuing the same habits that got you into debt in the first place,” says Raenna Jefferson, an associate planner with Zenith Wealth Partners. “Creating the plan is a one-time act, but changing your habits takes a lot more time.”
And the only way to break out of old patterns is to acknowledge and talk about them, according to Tara Unverzagt, president of South Bay Financial Planners. She says that the underlying beliefs we have about money — about how we should spend, save and invest — can lead us back into the same unstable financial situations we are trying to escape from.
Two examples of this behavior are avoiding talking about financial topics altogether and compulsively saving money. Identifying the root cause of your financial woes should allow you to isolate and correct the behaviors that left you in debt. It can also help you rule out payoff strategies that don’t make sense for you.
2. How much and what types of debt do you have?
A clear picture of how much you owe and to whom will allow you to choose a plan that focuses on the debts that are causing greater stress on your finances. For instance, high-interest credit card debt should almost always take precedence over low-interest student loans.
Knowing the types of debt you carry can also help you explore specific relief options. Loans secured by property like a house or vehicle, for instance, may have more limited options than unsecured loans.
Jefferson recommends you put all of your debts on a single sheet of paper and only then decide which debt payment avenue you want to take. You can categorize your debts by type, such as:
- Credit card debt: High-interest and typically unsecured.
- Student loans: May have flexible repayment options or be eligible for forgiveness programs.
- Medical bills: Often negotiable, with options for reduced payment plans.
- Auto loans or mortgages: Secured debts tied to assets you might risk losing if payments are missed.
If you have multiple high-interest debts, a debt consolidation loan can simplify payments and reduce interest. The average rate of a credit card is currently 23%, while Jefferson says rates on a consolidation loan are often under 10%.
Plus, “with a fixed payment schedule, you understand when your loan will be paid off and instead of paying multiple creditors, you are only paying one,” she says.
For medical bills, negotiating directly with healthcare providers or exploring hospital assistance programs may help. And if student loans are a large piece of your debt pie, you might want to look into income-driven repayment plans, which set your monthly payments based on what you’re earning, or refinancing options, which may help you lower your monthly bill through a lower interest rate or longer repayment term.
3. What are the interest rates on your debts?
The interest rate you already have (and what sort of new interest rate you can qualify for) will determine what sort of options are available to you.
Debts with high-interest rates accrue additional charges faster, making them more expensive to maintain. Credit cards are the best example of this. “Just understanding how a credit card works is huge,” Unverzagt says.
If you don't pay off the balance on your card each month, that means you're paying more than you might think for any purchases you make: A $100 pair of jeans only costs that amount if you pay it off before the interest kicks in.
Getting a balance transfer credit card to temporarily reduce interest and accelerate payments on high-interest credit card debt is one option. But Jefferson cautions against this. “Many will continue using the credit card and get back in credit card debt, while still paying off the balance transfer … putting you in a worse position than you started,” she says.
A debt consolidation loan might be a better solution for lower-interest debt — for example, debts with rates under 10% — but only if you can qualify for a rate that’s low enough to actually result in savings after you factor in any applicable fees. Otherwise, you may want to consider a self-directed payoff strategy like the debt avalanche and snowball methods.
The former prioritizes paying off the highest-interest debt first, saving money over time. On the other hand, if you need quick psychological wins to stay motivated, you might prefer the latter method, which focuses on repaying the smallest balances first.
4. Can you afford to make your payments on time?
Consistently making on-time payments is crucial to avoiding penalties and damaging your credit score.
If you’re struggling to keep up with payments, a debt management plan (DMP) offered by a nonprofit credit counseling agency is another option. These plans come with a small monthly fee. In exchange, you’ll work with a credit counselor to create a payment plan that usually includes reduced interest rates.
This is likely a better option if you need a little more hand-holding to get on the right track, Jefferson says. When you enroll in a DMP, you have to close out all your credit cards, so you don't have the option of spending more. Plus, credit counselors keep "your other monthly expenses in mind when calculating your monthly minimum payment," she says.
If you’re already behind on your payments and you’ve had a financial hardship (like a job loss or divorce), you could also try to settle your debts for less than you owe. You can do this yourself via negotiating or by working with a debt relief company.
While you’re focusing on how to get out of debt, don’t forget about savings. While it’s hard to accomplish both, try to build up at least a small emergency fund as you pay down your debt. Without a financial safety net, unexpected costs could easily disrupt your payment plan and send you spiraling further into the hole.
5. Do you have a strong credit score?
Your credit score is one of the main criteria that affects your eligibility for certain debt payoff options. Naturally, consumers with a better credit score will have access to a wider variety of choices and better terms overall.
With good to excellent credit (670 and above) you may qualify for balance transfer credit cards, low-interest personal loans or refinancing options that lower your rates. With fair to poor credit (below 670), your access to favorable terms will be limited, but other ways to get out of debt, like secured loans or credit counseling, can still provide relief.
6. Is your income low relative to your debt?
If your income is insufficient to cover your debts, you may need to explore alternative strategies. Ask yourself:
- Can I increase my income? Side gigs, part-time work and freelance opportunities can boost your regular earnings.
- Are assistance programs available to you? Nonprofit credit counseling agencies can help you create a manageable repayment plan. Programs like income-driven repayment (IDR) plans can reduce federal student loan payments based on your income.
- Is debt reliefan option? For those facing extreme financial hardship, negotiating with creditors to settle for less than the full balance might be worth exploring. Keep in mind this typically only works if you’re delinquent on your bills, which will hurt your credit.
- Can you qualify for Chapter 7 bankruptcy? This type of bankruptcy allows most of your unsecured debts to be discharged, meaning eliminated, in as little as four to six months. You do have to qualify via a means test that considers your income and finances relative to your debt, but for those who do, the success rate is very high. This will stay on your credit report for a decade.