Debt comes in many shapes and sizes. Sometimes you take on debt purposely, other times it creeps up on you, slowly or all at once. But no matter how or where it comes from, most can agree: Debt can be stressful and reducing it isn’t always so simple.
There’s no “right way” to reduce debt, but by exploring different strategies, you’re sure to find one or more that can work for you.
The impact of debt on your finances
One way to think about the various effects of debt is categorizing types by “good” and “bad.”
Some “good” debts are designed to help you invest in your future. For example, student loans (which can be a major investment into your earning potential) or a mortgage (which allows you to build equity and grow wealth long-term). “Good” debt is typically paid back over an extended term with relatively low interest rates.
Meanwhile “bad” debt is typically taken on for expenditures that will decrease in value, leaving you paying interest charges without building equity. Often, this type of debt is taken on in the form of credit cards that tend to have high annual percentage rates (APR), which can make paying down your balance take longer and cost more over time.
Interest charges can make debt expensive, essentially taking money from your future paychecks and making it harder to save for your goals. Taking on more debt will likely increase your debt-to-income ratio, making it tougher to qualify for loans you may need, such as a mortgage. Additionally, if debt begins to negatively impact your credit score, loans you do qualify for may come with higher interest rates all around.
Juggling saving while trying to pay down debt is a balancing act that looks different for every situation. When you find the sweet spot of building savings while chipping away at debt, you can set yourself up for a financially stronger future.
A clear path to a debt-free life
Debt doesn’t go away on its own and without the boost of windfall cash, it can be tough to pay back at once. Instead, you’ll likely find debt reduction requires repaying your debt consistently month-to-month. With a strategy, it’s easier to stay on track, keep sight of the end game and reduce chances of further accumulating debt.
With this method, list your debts in order by amount. Every month, make all your minimum payments, then put any funds leftover in your budget towards your smallest balance. As each debt gets crossed off the list, those funds now go toward paying off the next lowest debt. This method lets you harness the momentum of each small win.
The snowball can be a great way to reduce debt and boost motivation, but it may not right for everyone. For example, if your highest balance also has super high interest, it could cost you more to tackle that one last. Luckily, you have other options: such as avalanche, debt consolidation or debt management.
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The goal of the avalanche method is reducing total interest paid. To make this strategy work, pay the minimum balances on each debt and put any extra income toward the balance with the highest interest rate. Once that’s paid off, you’ll direct those payments to the balance with the next highest interest rate — and so on.
The avalanche strategy is an effective way to minimize the costs of paying down debt. But you might find it takes a while to fully pay off the first balance, leading to frustration or lack of motivation. For this method to work, it’s important to trust the process. Or you can try another strategy like snowball, debt consolidation or debt management.
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It’s tricky to manage debt from multiple sources with varying rates. Consolidating debts into one monthly payment can help. You may be able to do this with a credit card balance transfer or a debt consolidation personal loan. Homeowners might also consider tapping into equity with a home equity line of credit (HELOC) or cash-out refinance. By doing so, you’ll not only have to manage just one payment, but you may be able to reduce your interest rate. too.
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If debt becomes unmanageable, a professional credit counselor or a debt consolidation company may help. A debt relief program may help you negotiate more time or better rates, manage or consolidate your debts or pursue debt settlement. However, it’s important to know debt settlement is typically a last resort, as it can damage your credit score.
Powering toward debt-free living
Tackling your debt is an undeniable feat and something you should be proud of. To keep your accounts in the green going forward:
- Build a savings safety net
- Pay credit card balances on time and in full
- Stick to a budget
- Keep sources of debt to a minimum
Repay and stay away
Reducing debt may feel like an uphill battle. Committing to a strategy, staying focused and knowing you aren’t alone can help. With persistence and an eye on your target, you’ll see the debt you once viewed as a mountain turn into a molehill.
No matter where you stand, Ally helps make the most of your savings. Open an Ally Bank Online Savings Account.