What we'll cover
Difference between “good” and “bad” debt
Quiz to find a path to becoming debt free
Things to do after paying off debt
Debt comes in many shapes and sizes. Sometimes you take on debt purposely, other times it slowly creeps up on you or hits you 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 could 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. Think 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. This type of debt may be 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.
Interest charges can make debt expensive, essentially taking money from your future paychecks and making it harder to save for your goals.
A clear path to a debt-free life
A strategy to reduce debt can make it easier to stay on track, help you keep sight of the end game and reduce the chances of further accumulating debt. It’s likely you will find debt reduction requires repaying your debt consistently month-to-month rather than trying to pay it off all at once. Having a plan in place may help you stay on top of payments so you can crush your goal of becoming debt free.
Snowball strategy
With the snowball method, list your debts in order by amount. Every month, make all your minimum payments, then put any funds leftover in your budget toward 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.
Pros | Cons |
|---|---|
Simple to start using | May cost you more if your highest balance also has super high interest |
Small wins can boost your motivation and keep you going |
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Avalanche
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.
Pros | Cons |
|---|---|
Saves money on interest | May need extra money to put toward debt |
Structured approach to paying off debt | Could be difficult to stay motivated because it may take a while to fully pay off the first balance |
Debt consolidation
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.
Pros | Cons |
|---|---|
Simplifies debt because you will only have one monthly payment | May face high upfront fees |
Could secure a lower interest rate | Could come with a higher interest rate than what you currently pay on your debts |
On-time payments could increase your credit score | Need to be eligible |
Debt management
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. It’s important to know debt settlement is typically a last resort, as it can damage your credit score.
Pros | Cons |
|---|---|
Simplifies debt because you will only have one monthly payment | Creditors may not agree |
Could secure a lower interest rate | May be required to close one or more credit accounts |
Can get advice from a professional | Could hurt your credit score |
Powering through 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
You may also consider creating spending buckets, a feature of Ally Bank’s Spending Account. You can have up to 30 spending buckets to track anything from groceries to bills and more. You decide how much money is needed for each bucket and how often. Spending buckets make it easy to track where your money is going and to see how much you have left over.
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.
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