How to Pay Off Debt: A Guide for Millennials

• While paying down debt is a challenge for many consumers, with a well-formulated plan and a bit of discipline you can become debt free.
• Before you begin aggressively paying off debt, ensure that you have an emergency fund in place.
• Determine how much debt you owe as well as monthly take-home pay, then choose a debt repayment strategy that works for you.

If you’re like most Americans, you probably have debt. In fact, according to the Federal Reserve Bank of New York, household debt in the United States climbed to its highest ever, at over $13 trillion in the first quarter of 2019.

While your personal debt is a challenge to financial stability, it’s a challenge you can overcome with a bit of planning, and a lot of discipline. No matter whether you have student loans, credit card debt, car loans, or a combination of all three, there are tried and true methods you can use to pay off debt faster. However, just as you didn’t get into debt overnight in the first place, paying off that debt will take time — and a concerted effort on your part.

First, an Emergency Fund

While paying off debt should definitely be high on your list of personal financial goals, you should establish an emergency fund before you start aggressively paying down your debt. What would you do if you lost your job, had a medical emergency, or got hit with an expensive car repair?

Being prepared for the worst can help you survive such events, if not completely unscathed, at least financially secure. As a result, financial experts recommend having a minimum of three months’ — and preferably six to nine months’ — worth of essential living expenses stashed away in an easily accessible savings account.

However, if you’re determined to pay off your debt as soon as possible, save at the very least $1,000 or two weeks’ pay, whichever is more, to cover any unexpected expenses. To develop your savings habit, direct an amount of each paycheck — however small — towards your emergency savings each month. With a cushion in place, you can protect yourself from falling further into debt in order to cover emergency expenses, which would undermine any aggressive debt repayment strategy you had put in place.

Determine How Much Debt You Have

While saving up a minimum amount in your emergency fund, you also need to evaluate your debt situation. After all, before you dive blindly into paying off your debt, you need to know just what you’re up against. Figuring out the exact number that you owe is the first step toward financial freedom. It may take some time, and a bit of courage, but you should sit down and tally up the total amount you owe, as well as the interest rate on each of those debts.

The easiest way to start is to look at your credit report. You can get a free copy of your credit report from the Federal Trade Commission, or your bank may also provide a free credit report service that you can use to view your current report. On your report, you can view all your debts in one place, listed out under the various types:

• Credit cards
• Auto loans
• Personal loans
• Student loans
• Mortgage

Your credit report will give you a good overview, while the details of each type of debt can be found on your statements. For each type of debt, find out the amount you owe and the interest rate on each account, as these will play a crucial role in helping you come up with your debt payoff strategy. Finally, determine your minimum monthly payment for each account.

As an example, let’s examine Claire’s finances. After looking at her credit report and reviewing her financial documents to determine the interest rates and minimum monthly payments on her debt, she came up with the following:

Now that she knows how much she owes in total, as well as the bare minimum she needs to pay each month, it’s time to formulate a debt-payoff strategy. But first, she’ll need to figure out her monthly budget.

Figure Out Your Budget

When creating a budget, the first step is determining how much money you’re bringing home every month. From there, you can use the 50/30/20 budgeting rule to help determine how much you can reasonably put toward your debt each month. (If you’ve never created a budget in your life, this worksheet can help you get started.)

This type of budget buckets your monthly expenditures into three categories:

1. 50% Needs: This percentage includes all the expenses you have to pay every month to get by. For instance, rent, electricity, insurance, groceries, and prescription medication. You should also include your minimum monthly debt payments in this category, as it can severely impact your credit score — and overall financial well-being — if those payments aren’t made on time and in full each month.
2. 30% Wants: This category includes expenses that bring you joy, but which are not absolutely essential to your well-being. In this category you would include things like shopping, dining out at restaurants, vacations, and hobbies.
3. 20% Savings: This is the category you’ll want to focus on when paying down debt. With the 50/30/20 rule, you should put at least part of the 20% toward repaying debt above and beyond the minimum payment you’re making from category one on this list. This is also where you’ll draw funds to create an emergency fund, and save for long term financial goals.

For instance, revisiting Claire’s case, let’s say she nets $5,000 per month after taxes. Also, in Claire’s case, let’s assume she has already fully funded her emergency savings account, and has decided to focus solely on using her 20% savings bucket ($1,000) to pay down her debt.

Given that her minimum monthly debt payments are $500 per month from her 50% needs category, she calculates that she can put at least $1,500 toward her debt each month.

By putting an additional $1,000 in extra payments toward her debt, Claire can greatly accelerate how quickly she can pay off her loans. But knowing which loans to pay off first can help you get out of debt even faster.

Set Up Automatic Payments

Now that you know how much you owe and have budgeted for your minimum monthly payments on each debt — automate those payments. This ensures that even if you have multiple debts, you’ll never forget a payment. And by always paying on time by the due date, you won’t incur any late fees that could potentially slow down your progress.

Prioritize Your Debt Payoff Using One of Two Methods

No matter what, putting any extra cash you can toward loan payments will help you get out of debt faster. Personal finance experts generally recommend one of two methods to help speed up the process even more:

• The Debt Avalanche
• The Debt Snowball

Which method you choose will depend on what motivates you more — saving money, or seeing quick progress. With either method, there are pros and cons, but in the end, being disciplined with your payments is ultimately what will propel you to debt-free status.

Method 1: Debt Avalanche

Remember how you added the interest rates on each of your debts to your overall debt tally? That’s because not all debt is created equal. If you want to save as much money as possible while repaying your debt, the best strategy is to pay off those debts with the higher interest rates first, as these will cost you the most in interest payments over the life of the loan.

To use this method, follow three simple steps:

1. Pay the minimum amount on all your accounts.
2. Put as much extra cash as possible toward the account with the highest interest rate.
3. Once your loan with the highest interest rate is paid off, put the monthly payment of your first loan plus any extra money toward the loan with the second highest interest rate. Continue until all your debts are paid.

In Claire’s case, we can see that her highest-interest debt is her credit card, at 19.25%. Her lowest interest rate loan is her auto loan, at 3.00%. If she were to make just the minimum payment on each loan until it was paid off, she would pay drastically different amounts in interest due to the difference in interest rates:

Even though her credit card balance is almost half of what she owes on her car loan, due to the credit card’s significantly higher interest rate, she would pay almost 22 times as much in interest without the debt avalanche approach. With the avalanche, her debt priority payment list would look like this:

She would pay the minimum amount on all her loans, which totals $500.00 per month. Since she determined she can put an additional $1,000 of her monthly income toward paying off her debt, she would put that extra cash toward her credit card debt. In other words, she would be paying a total of $1,050.00 toward her credit card every month until it was paid off ($50 minimum payment + $1,000 additional payment).

Once her credit card was paid off, she would move on to her private student loan, putting all the money she had been paying toward her credit card toward the loan ($150 minimum private student loan payment + $50 minimum credit card payment + $1,000 additional payment) for a total of $1,200 per month.

Like an avalanche, it might take time before you pay off each debt. But you will pay significantly less in interest payments over the life of each loan when you use this method.

Method 2: Debt Snowball

While the interest rate on each of your debts are a key consideration when choosing how to prioritize your debt-payoff strategy, there is also the matter of your motivation. If you need quick wins to keep going, the debt snowball method might be for you.

In the debt snowball method, rather than prioritizing debts by their interest rate, you would put them in order of the debt balance, with the lowest account balance coming first. Then, follow this three-step process:

1. Pay the minimum amount on all your accounts.
2. Put as much extra cash as possible toward the account with the smallest balance.
3. Once your loan with the lowest account balance is paid off, put the monthly payment of your first loan plus any extra money toward the loan with the second lowest account balance. Continue until all your debts are paid.

If Claire were to use this method to pay off her debts, she would put them in the following order:

Again, she would pay the monthly minimum amount totaling $500.00 on all her loans. Then, she would put her extra $1,000 toward her federal student loan, paying a total of $1,100 on that loan each month until it was paid off in full ($100 minimum payment + $1,000 additional payment).

Once her federal student loan was paid off, she would move on to her credit card debt. She would snowball her payments, adding up everything she had paid toward her federal student loan, plus her minimum credit card payment ($100 minimum private student loan payment + $50 minimum credit card payment + $1,000 additional payment) for a total of $1,150 per month toward her credit card. She would continue this process until all her loans were paid off.

While you might end up paying more in interest payments using this method, you can achieve quick wins as you knock out one debt after another, and keep yourself motivated until the last debt is paid off and you’re blissfully debt-free.

Tactics to Speed Up the Process

Once you’ve calculated how much extra money you can put toward your debt repayment each month and chosen a debt payoff strategy, you might wonder if there’s any way you can pay off your loans even faster. Yes, you can, but it will take some additional effort on your part.

Spend Less

Finding a way to spend less, and therefore save more, is one of the quickest ways you can speed up your debt repayment process. If you’re using the 50/30/20 budgeting method, you might find ways to save on your monthly necessities, or allocate some of your “wants” money toward lump sum debt payments, even if just temporarily while you work towards your goal. In the end, even a little extra cash helps, so finding creative ways to save can drastically speed up your timeline to financial freedom.

Make More

Once you’ve trimmed your spending to maximize your monthly debt payments, the next option to accelerate your debt payoff process is to bring in more cash every month — and then put it toward debt payments.

For instance, you could ask for a raise at your current job or increase your earnings by taking on a side hustle outside of your 9 to 5. While many people drive for Uber or Lyft to supplement their income, there are other options you can pursue that align with your interests and skillset. For example, you might take on some freelance writing, start a dog walking service, or start selling products you’ve made in online marketplaces like Etsy.

Lower Your Interest Rates

Finally, you might consider ways to lower the interest rates on your debt. By paying less interest on as many of your debts as possible, you can free up cash that would have gone toward interest payments to put toward your principal balance — resulting in an accelerated debt payoff. However, with different types of debt, there are different options for lowering the interest rate.

Credit Card Debt

With credit card debt, using a balance transfer card is an effective means of lowering your interest rate, and the amount of interest you pay. These credit cards have a 0% APR introductory period, usually for a period of between six and 24 months. If you’re approved for one of these cards, you can transfer your balance from the high-interest credit card to the new card. Then, during that initial grace period, all your payments will go strictly toward the principal of your balance.

But take note — you should not use this card to make new purchases, and pay off the debt within the 0% APR grace period. Otherwise, the remaining balance will be subject to the card’s regular interest rate, which may be even higher than your old card — putting you back at square one.

Student Debt

The primary option for lowering interest payments on student loans is through student loan refinancing. In general, you can refinance both federal loans and private student loans by paying off the original loan with a loan borrowed from a third party lender. This new loan offers a different repayment plan, and usually a lower interest rate. This can save you thousands of dollars in interest over the life of the loan, freeing up more money for your debt avalanche or debt snowball.

Car Loans

As with student loans, you also have the option of refinancing auto loans. The basics of an auto loan refinance are the same: You pay off your initial loan with a new loan from a third-party lender at a lower rate. Again, by refinancing at a lower interest rate, you can potentially save thousands in loan interest on your car payments over the loan term.

Enjoy Being Debt-Free

The debt repayment process isn’t easy, and may seem daunting at times. However, if you stick to your chosen debt repayment strategy, the day will come when you pay off your final balance. On that day, you can do a little dance and be proud of yourself. You’ve been disciplined and diligent, building healthy financial habits along the way.

Now you can take a breath and look toward the future. After all, you’ll suddenly have quite a bit of extra cash each month that you don’t have to give to someone else. With your debt repaid, you can now put your hard-earned money to work for you, further padding out your emergency fund, saving for retirement, or even investing to build wealth.