How to Get Out of Debt: Choose a Repayment Plan

To develop a debt payoff plan, you must be able to answer two questions: First, how much money can you pay off each month? Second, what should that money target first? Usually, if you are able to pay your bills, the next step may require you to determine which balance deserves extra payments. Conversely, if you cannot pay your bills, speeding up your debt payoff plan will not help close your shortfall.

Start with the numbers below and then consider the following: paying debts in a set order, changing the terms of the debts, or getting help with debts you cannot manage on your own. These routes will serve different needs. You do not have to attempt all of these routes.

Find out whether you have extra money or a payment shortfall

Current statements will provide your balances, interest rate, required payments, and the due dates. Add delinquent amounts (overdue amounts) and any promotional-rate deadlines. Be sure to identify debts secured by property (mortgages and auto loans, for example) because the property is collateral and may be at risk if you default on your loan.

Account for how much you have left after take-home pay covers living costs and required debt payments. Consider less frequent costs, like your annual insurance bill, when making your plan. Set aside cash for unexpected costs and changes in spending. Planning for emergency savings and debt payoff while dealing with repairs can prevent you from racking up credit card debt.

Hypothetical Monthly Budget: Take-home pay is $3,200. Living costs, including money set aside for irregular bills, are $2,450. Required debt payments are $400. $100 is set aside for a cash reserve and spending cushion.

$3,200 – $2,450 – $400 – $100 = $250 for extra debt payments. Total debt payments would be $650, not $250. With a $300 rise in living costs, the same plan would be $50 short. To address the gap, optional extra debt payments would need to be stopped.

An accumulated positive monthly balance doesn’t mean cash is available on every due date. Compare paydays with payment dates. An adjustment of due dates may resolve a timing problem, but it can not resolve a short budget each month.

If money will not cover everything, prioritize food, housing, utilities, and transportation to work as well as necessary medications. Consider the consequences of each unpaid bill rather than paying whoever calls most often. An overdue secured loan or a court deadline may need attention before an extra card payment. Contact the provider or creditor regarding your situation. Get legal help as soon as you can if you face eviction, repossession, or are sued.

If required payments fit: choose where the extra money goes

With both the debt avalanche and debt snowball, required payments are made on other accounts. The difference is where the extra money is directed. The table uses made-up balances and payments to illustrate the choice. All the accounts are current, and no account has a special payoff date.

Debt avalanche: target the highest rate

With the $250 additional money from the budget example, $320 would be paid to Card B. Card A would receive $30, and the personal loan would receive $300. The total remains $650.

For a given payment budget, it normally results in lower interest costs to pay down the higher-rate debt first as compared to paying the lower-rate balances first. This assumes stable interest rates, no new borrowing, and no special fees. The first account you clear may take longer if it has a large balance.

Debt snowball: target the smallest balance

Under the debt snowball method, you would pay $280 to Card A, $70 to Card B, and $300 to the personal loan. Clearing a small account first may increase your commitment to the plan. However, the remaining balance with the higher interest does continue to accrue while you pay down the lower balance.

No matter which method you use, if you can, keep the total payment amount the same when an account is paid off. Direct the former payment to the next account. This example shows the first month’s payment allocation. It is not a payoff date. Later payment amounts may be different due to interest and changing card minimums.

Learn how your lender uses extra money when sending additional payments to an installment loan. The payment could reduce your principal, pay off fees, or be applied to interest that has already accrued. The next payment could also be reduced. With a personal loan, how your loan is repaid is determined by the loan contract, and could also include charges for paying off your loan early. Be sure to request a payoff amount that is valid until the date your payment will be received.

A special deadline can change your order. An offer of “no interest if paid in full” can use deferred interest. If the balance is not cleared by the deadline, interest may be charged back to the purchase date. This is different from a true 0% offer. You should confirm the deadline and payment allocation with the issuer before considering that balance your cheapest debt.

If the terms are the problem: change the payment or cost

Ask the creditor about a hardship arrangement

You should reach out to your creditor as soon as you recognize a required payment looks out of reach. Some accounts may provide the option of a lower payment, reduced interest, waived fees, or a pause on payment. These options are not provided in all cases.

Be realistic when thinking about the time frame and the amount you can afford. State something like “My required payment is $180. I can pay $100 a month for the next three months. Is there a hardship plan that fits that amount?” This shows that you are interested in making some kind of payment and is not an agreement to pay less.

Get offer details in writing. Ask whether interest accrues during the relief. Learn how postponed payments are treated, and find out how the arrangement will be reported to the credit bureaus. Check how postponed payments are treated under the terms of the loan. For example, will payments be moved to the end of the loan, or will there be a catch-up amount?

Use consolidation only after comparing the remaining costs

A debt consolidation loan combines multiple debts into a single new loan. This loan doesn’t eliminate what you owe. If monthly payments on the new loan are less, this can free up cash flow. But a longer term on the new loan means that the total amount paid over the life of the loan could increase.

Look at costs going forward. Figure out the payoff amounts for the old debts. Then look at their remaining payments and compare those to the total of the new loan and any additional fees. With credit cards, when thinking about the old debt, you have to come up with a payment amount and make some assumptions about rates and purchases. A statement’s minimum payment estimate is not the right comparison to think about the cost of carrying a card balance if you plan to pay more than the minimum.

Hypothetical Cost Comparison: Let’s say the debts being replaced would require $6,900 in remaining payments under your current plan. A new loan has 36 payments of $185 and a $200 upfront fee.

$6,860 = 36 x $185 + $200. Estimated savings would be only $40. If the fee were already included in the scheduled payments, you would not add it again. A smaller monthly payment would not be enough to illustrate this small difference.

Also, confirm the money left after fees are removed is enough to clear the debts you want to repay. Compare the annual percentage rate (APR) of the credit options and the cost of credit in dollars. When you borrow money against your home or car to pay unsecured cards, you add the risk of losing that property. You may end up with both the new loan and new card balances to pay again if you run up the card again.

Test a balance transfer against its actual deadline

The interest rate may be reduced for a certain period as a promotional balance transfer offer. Transferring a balance may also incur a fee. Factors like approval, credit limit, and which balances may be transferred are determined by the issuer.

Let’s say you transfer $3,000 and a 3% fee is added to the balance. You would owe $3,090. If a true 0% rate covers that amount for 15 monthly payments, you would need to pay $206 a month to clear it in that time. This assumes no other fees, purchases, or changes to the offer.

Paying $150 a month means you would pay $2,250 within the 15 payments. After the 15 payments, you would have about $840 remaining on the account. Check the end date and see what the rate is after that. You should continue to pay the old account until the transfer posts. New purchases made on the transfer card may charge you interest while the transferred balance is still at 0%.

If the debt still will not fit: compare forms of help

Consider a debt management plan through credit counseling

A credit counselor can evaluate certain unsecured debts for a debt management plan. Participants make a single payment to a credit counseling organization. The organization then makes payments to the creditors. Creditors may lower interest and/or waive fees. The debt management plan focuses on repaying the debt, not settling the debt for less.

Nonprofit status does not mean every service is free or suitable. Request fees and a payment schedule in writing. Confirm which creditors have agreed to participate and if the accounts will be closed. Take debts outside the plan into consideration when determining if the payment is reasonable. Continue to make payments required of you until you know when the plan payments will begin.

Understand settlement before agreeing to pay less than you owe

Debt settlement is when a creditor or collection agency agrees to take less than what is owed. This can be done in a lump sum or in installments. Any creditor has the right to refuse to settle your debt. Negotiating debt settlements can be done directly. You don’t need to enlist the help of a settlement company.

If a collector contacts you, first verify the debt and the amount with the validation information provided. According to the CFPB, negotiating with a debt collector typically involves getting their promises in writing prior to making payment. The agreement should explain what completes the settlement and what happens to the remaining balance.

Settlement companies may want you to stop paying creditors to build up money for an offer. In the meantime, interest and fees may build up. Your credit may suffer, and collection activities and lawsuits may continue. Avoid offers for guaranteed savings and requests for advance settlement fees.

Debt forgiveness is considered taxable income. There are exceptions and exclusions to this rule (e.g., bankruptcy, insolvency). Insolvency occurs when your debts are greater than the value of your assets right before the debts are forgiven. For more information on how this applies to you, contact a tax professional. For old or disputed debts, get legal advice before making payments on the debt or admitting that you owe it. Do not ignore court papers while trying to negotiate a settlement.

Seek legal advice when repayment is not realistic

A revised plan may still not cover your debts. In this case, a bankruptcy attorney or legal aid service can review your options. Bankruptcy is a relief from debts rather than simply another payoff order. Receiving advice on this option will not obligate you to file for bankruptcy.

Chapter 7 may discharge certain debts and may involve the sale of property that is not protected by exemptions. Chapter 13 uses a court-approved repayment plan that generally lasts 3 to 5 years and provides debt relief for people who have regular income. Other considerations that may affect eligibility, the protections given to property, and which debts may be discharged are the law and the circumstances of the person. Credit consequences are also important. Advice should be sought before savings are drained or property that may be protected is sold.

Make the next payment part of a plan you can repeat

Pick a route using the budget that you actually have. If your required payments fit, name a target debt and a specific extra amount. If they don’t fit, start with a creditor conversation or a counseling appointment instead of assuming you can pay faster.

Next, verify payments have been posted, and the intended balance has fallen. If not, check if there are interest charges, fees, new purchases, or a payment-allocation issue. Make adjustments to your plan if your account terms or your income change. Progress should be the result of a payment you can make repeatedly that does not create a new balance to cover the rest of the month.