The Best Way to Pay Off Debt

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It’s that time of year when people start picking their New Year’s resolutions! Money goals in some form- whether it’s to pay off debt or save more money- is usually one of the top New Year’s resolutions year after year.

Some of the reason this comes into focus is because people spend so much on the holidays, use a credit card to “afford it”, and then have that credit card bill to pay off in January! For this reason, we’re going to focus on the “pay off debt” New year’s resolution.

If this is the area of personal finance that you’ve made your New Year’s resolution for this upcoming year, let me help you make some progress with this goal so you’re still sticking to it by Christmas next year!

Where to start when you want pay off debt

Paying off debt can feel so overwhelming because there are so many things to consider or do simultaneously to get the ball rolling.

First and foremost, the very first thing you do, regardless of your income, get on a budget right away! Examine your income, expenses, and spending habits. You’ll be surprised at how much “extra” money you’ll find once you start cutting out unnecessary spending.

I won’t dwell on this too much here as I want this post to focus on untangling a mess of debts. I’m going to assume you’ve done the work to either make the most of the income you have, increased it where possible, cut out frivolous expenses, and reduced other expenses where possible.

To get started on your budget, see this post.

I’ve figured out my budget. How, or where, do I start to pay off debt?

I’m going to speak about worst case scenario, like you’re contemplating bankruptcy because you have so much debt weighing you down. I hope you’ll seriously consider walking through the methods I outline here before taking such a drastic step.

When first analyzing your debts, it might be easier to start a process of elimination to get down to what’s really important and where you need to focus.

First, I’ll have you groups your debts in order of importance, and then payoff those groups from smallest to largest.

You can’t skip over this. You absolutely need to organize and prioritize your debts.

I know, you’ve just done all this work with your budget and you don’t want to organize anymore. But you have to. You do it, and I promise you’ll be successful. If you just throw debt payments at whatever is in your face at the moment, you’ll make no headway. Having a plan will also give you a sense of control over your situation.

What’s the most “important” debt?

Your first priority debt is the ones that threaten your home: electricity, water, mortgage, and maybe property taxes. Regardless of what debt is the smallest or has the highest interest rate, these take precedence. These need to be handled first so that your home is secure.

You do have a little bit of leeway with property taxes as you generally can not pay for four years before they take your home, but I do NOT recommend doing this. The interest on your past due taxes is very high, and you don’t want to put yourself in a position to lose your home. You should work to get these caught up ASAP!

If you have these debts, your priority is to “keep the lights on”. Try negotiating any past due amounts. If you commit to paying something by a certain date, make sure you do it!

Simultaneously, you should be negotiating with your lender and maybe your county if you have a problem with paying your mortgage and property taxes, respectively.

What’s the least important debt?

I think of debt with two bookends: house debts… and collections.

If you have any debt in collections, they will be last on your list, you can ignore them for the time being.

Here’s why I tell you to somewhat ignore this debt for now: If you have debts in collection, your credit score is already tanked and tainted with these collection accounts so not paying your collections doesn’t do any more damage than is already done. This is why these are last priority.

You can typically expect to negotiate your collection debts and settle sometimes for less than what is owed (get it all in writing first!), which you should then insert into your smallest-to-largest debt line up.

I owe taxes. Shouldn’t I pay these first?

If you owe State and Federal taxes, these still come after you’ve secured your home, but they should come before you pay anything else. These are very serious and do need to be handled as quickly as possible.

You have very little room to negotiate any settlements, but you could try. Typically, the most you would get is not having to pay the interest, or at least a reduced amount of interest. Have no doubt: the government will get its money so work with them the best you can.

Whatever you do, do not NOT file your tax returns. Even if you don’t pay the money that you owe, file those returns. Your penalties for not doing so, and the interest you pay on those penalties, are actually higher than the interest on the tax you do owe, usually. You don’t want to compound your problems by adding more uneccessary debt.

Household debt, then taxes, and collections are last. What about the rest of my debt?

After you’ve organized all that other debt, line up all the rest from smallest to largest and plan to take them out in that order.

In this step, look to see if there’s anything you can sell. I’m not just talking about selling your household goods in a big garage sale (although you should think about that, too), but some of your larger, more valuable assets.

Have car debt? Can you sell the car and purchase a less expensive one? This can help eliminate a large chunk of your debt very quickly, which can be psychologically motivating to finish off the rest. 

If you end up with a deficiency loan (the difference between what you received for sale of the asset and what you actually owed), put that back in line with your other unsecured debts.

During this process, it’s okay to be flexible. If you’ve agreed to settle a collections account for $400 by a certain date, don’t worry about the $200 and $300 debts that are next in line. If that $400 needs to be paid now, pay it now! Don’t be fixated if it’s not the smallest debt right now. Just pay it and then get back on track with your plan.

Negotiate, negotiate, negotiate

Once organized, start working to negotiate some of your debts, starting with the mortgage. See if you qualify for any sort of relief programs, or if there’s any other way that you can manage to pay for and stay in your home (if it’s actually affordable for you to live there). Negotiate with your utility companies to see if you maybe you could settle your past due amounts for less.

If you’re like the average person, you have almost $33,000 in student loan debt! Most student loans are through the government, and those don’t go away when you declare bankruptcy. So even if you did go that route, you’d lose your credit card debt…and your car and your home… but you’d still have Sallie Mae to keep you company. And then the stain of the bankruptcy sticks with you for years, making it hard if you’re looking for jobs (that require credit checks) or wanting to buy a house in the future.

Negotiate any student loans for hardship deferrals and any other programs that may be available to you. Be careful to understand all the terms, as the deferrals may just be adding on interest to the back end. If it helps you pay off other debt for now, that’s fine; but just be sure you understand what you’re doing.

If you have any collections accounts, start negotiating those for any settlements, get the agreement in writing, then add it to your debt pay off line up.

What if I can refinance my debt?

I’m not opposed to refinancing or even consolidating these debts if you’re able and if it helps. If you know it’s going to take a while to get to that $10,000 that has a 10% rate, and you have the opportunity to refinance that debt at 3%, yes, take it, as long as the loan fee isn’t outrageous. Having the lower interest rate helps stop the bleeding and will maybe reduce your anxiety. Yes, you’re just shifting debt. But trying to reduce the accumulated interest is helpful to you in the long run so I’m okay with it.

If you are considering refinancing, you should check out SuperMoney! You can compare different options all in one place so you don’t have to go hunting and pecking on your own for the best deal. I’m a fan of being able to compare rates and terms all in one place instead of switching from one website to another to compare their products. If you think a consolidation loan or refinancing would be helpful to you, definitely do research and use SuperMoney to compare terms so you’re not spending more money than you’d actually be saving.

Final thoughts on your “pay off debt” resolution

I think the biggest mistake people make is getting emotional about their debt.

I get it, maybe you feel depressed, overwhelmed, scared, etc. You may feel like you’re in such a big hole that you’ll never be able to get out of it, and why bother trying? That’s normal. Feel those feelings, then get to work.

Going through the process I’ve outlined- getting on a budget and organizing your debts- will help you approach the situation with more of a business-like mindset, which removes some of that emotion. You’ll also feel a greater sense of control over your situation, which is positive for you mental health overall.

Lastly, mindset is everything. If you’re really focused and serious about eliminating debt, using the methods I’ve outlined here, you’ll probably surprise yourself by paying off your debt faster than you intended.

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