Create a debt payoff plan to take advantage of every extra cent and build momentum to get out of debt more quickly and strategically.
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If you’re new to the Financial Security Steps, start here: Welcome!
Debt payoff is usually the longest, hardest part of the path toward financial security. It can take years to pay everything off, especially if you don’t have an expensive asset, like a car or RV, to sell and pay off the related loan. The debt snowball may be the most popular method, but you can also use an avalanche method or a combination of the two. Today you’re going to prepare for that long haul.
The most important part of making your debt payoff plan is to structure it in a way that helps you stay motivated and dedicated. Your mentality is the biggest factor in your success.
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How do you pay off debt anyway?
First, get current on all your bills
Ignoring an overdue bill is either going to get your service turned off or you’ll be sent to collections eventually. Keep your mini emergency fund intact, but put any extra funds to catching up on monthly bills.
If you have large bills that you can’t possibly pay right away, contact the company to work out a payment plan. Most medical institutions will let you make very small monthly payments, as long as you are paying something each month. Your electric company may let you pay an extra $20 a month until you’re caught up. The important thing is to make the effort, to show the company you are serious about taking care of your obligations.
Second, choose a debt payoff method
Keep reading to see the three options. Don’t worry too much about math and interest right now, just choose the method that will keep you motivated long-term.
Third, list your debts on the Debt Payoff Planner in the order you’ve chosen
This is going to be your plan, your best friend in the debt payoff journey ahead of you. You’re going to refer to this plan when you’re creating your budget, when you set up monthly debt payments, and when you adjust payments
Fourth, schedule transfers to your “bills” account
Add up the total of the minimum payments on your sheet. Make sure to transfer this amount to your “bills” account (see Financial Security Step 3: Save for Recurring Expenses for details on how to calculate your transfers).
Finally, start paying your debts off
After you have all your debts and their details listed on the Debt Payoff Planner, you can start paying things off!
Pay the minimum on ALL of your debts, EXCEPT THE FOCUS DEBT. Your focus debt is the only one you’re paying extra on. Focus on a single debt to eliminate it as quickly as possible {while keeping everything else current by making minimum payments}. Concentrate your efforts in a single area to make progress and actually feel like you’re moving your debt total downward, whether it’s with the debt snowball or debt avalanche.
Right now, without a budget (see Financial Security Step 6), you don’t know exactly how much extra you can pay on your debt. That’s fine! You’ll update figure that out soon. Today, just figure out your minimum payments and be patient until you complete Step 6.
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The debt payoff order matters… somewhat
You can spend hours calculating different payoff scenarios, figuring out how to pay the least interest, or how to get out of debt the fastest. It doesn’t really matter which method you use, as long as you feel motivated to keep going. Paying off the first debt is exhilarating, but the long haul through a larger debt is boring AND discouraging.
Choose the method that works best for you & your situation.
Debt Snowball Method
The debt snowball method is Dave Ramsey’s baby and involves paying off your debts strictly in order of balance, from lowest to highest. The psychological benefits may be greatest here because you get the early “win,” but you’ll probably end up paying more interest over the duration of your debt payoff plan.
Debt Avalanche Method
The debt avalanche method has you pay off debts based on interest rates, with the highest interest rates first. This will probably save you money in the long run (do the math if you’re skeptical), but you could end up working on your 27% credit card debt for the entire first year of your debt payoff plan. That’s discouraging… and may be enough to psych you out until you just stop focusing on debt pay-off entirely. That’s not good either.
Hybrid Method
AKA, the “whatever works” method. Make up a payoff order that keeps you engaged, focused, and sane.
For my family, we started off by focusing on the highest interest rate debt (a credit card), even though it had a balance somewhere in the middle of the list. I just couldn’t get past the math of paying that much interest for longer than we had to. Next, we knocked out a couple of small 0% debts (a promotional credit card and a medical debt), simply because they were the smallest balances. Then we’ll tackle a low-interest rate credit card (mainly because it annoys me). After that, we are planning to follow a more traditional debt snowball pay-down because everything left has similar interest rates.
Download the Debt Payoff Planner now
Create your Debt Payoff Plan by listing:
- all your debts & their balances
- the interest rates
- the minimum payments
- due dates
You gathered all this information when you completed Financial Security Step 4, Calculate your Net Worth. Use the Debt Payoff Planner to list everything in the order you’ve chosen. Keep the print-out & update it whenever you pay off a debt.
This makes it super easy to know how much to pay on the focus debt. When you pay off the first debt, add its minimum payment to the minimum payment of the next debt. Write this amount in the Rolling Payment column. That’s how much you’ll pay on the second debt until it’s paid off.
Continue this for each debt. If your budget allows for extra payments, apply those to the focus debt. When you make extra money, apply that to the focus debt.
The rolling payment is the secret weapon
Make the minimum payments on all your debts except the focus debt. Throw any extra money at the focus debt until it’s paid off.
Then move down the list, adding the minimum payment from debt 1 to the minimum payment of debt 2. Debt 2 is the new focus debt, and you can make even larger payments.
As you pay off each debt, roll the payments you were making to it into the payment for the next debt on your list. By the time you get to your last debt, you’re going to be making pretty big monthly payments (the cumulative of all those smaller minimum payments).
If your budget allows for extra payments, apply it to the focus debt. You’ll figure out the extra amount in the next step, but don’t include it in the rolling payment because it can change. You should definitely make those extra payments on your debts though.
When you make extra money, apply that to the focus debt. One-time payments could be a tax refund, a bonus at work, overtime, or a side hustle. Don’t include those amounts in the rolling payment because they are not recurring.
Lump-sum payments can really accelerate the overall timetable of your debt payoff. In October we were able to make an extra $3,000 payment due to a bonus and an extra paycheck that month, which cut 4 months off our debt payoff timeline.
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for example…
- Credit card with a $1,000 balance @ 27% interest, minimum payment of $50
- Credit card with a $4,000 balance @ 15% interest, minimum payment of $100
- Student loan with a $9,800 balance @ 5.8% interest, minimum payment of $150
- You can pay an extra $200 per month on your debts.
Using the debt snowball method, you’ll focus on the $1,000 balance credit card first. You’ll pay $50 + $200 each month, making the minimum payments on the other two debts.
After that credit card is paid off in 4 months, you will apply that amount to the $4,000 credit card, which means you’ll pay $50 + $100 + $200 (the two minimum payments + the extra). Once that credit card is paid off, pay $50 + $100 + $150 + $200 on the student loan until it’s also paid off.
If you’re using the debt avalanche method, the process is the same, but the order differs. You would pay the debts off based on their interest rates (27%, 15% and 5.8%)
A debt payoff plan gives you guidance
Yes, it’s going to take a long time. Making extra payments is going to help a lot, which is why many people look for ways to both increase income and decrease debt during their debt payoff plan. It requires hard work and sacrifice, but it can be done.
The long timeframe is why I want you to choose the payoff method that gives you the most hope. You have a better chance of success if you win the mental game rather than the math game. Math isn’t going to keep you pursuing this dream when you don’t have the budget to eat out and you’re craving pizza, but being in the right headspace will help you enjoy the homemade pizza you whip up.
The debt snowball method makes less sense from a math standpoint than the debt avalanche, but it is popular because of the mental aspect. If you need a quick win, it’s a good option.
Now that you know your net worth, you can see how far you’ve come. Following your debt payoff plan will keep you on track and help you stay motivated.
It’s going to be hard but you can do this.
Nice explanation of the task! Inspiring, too!
Thanks for reading Karen!