Debt can be an overwhelming source of financial pressure and uncertainty, affecting your overall well-being. Getting out of debt is one of the most impactful financial decisions you can make and a key component in a secure financial future. Decreasing your debt can give you more financial freedom, reduce stress and anxiety and better position yourself for retirement.
The first step to reducing your debt is obvious: Stop taking on more debt.
After that, do a deep dive into your budget to determine the maximum amount you can pay each month toward reducing your balances. Where can you trim your spending (particularly in those nonessential areas) so that you have extra money to put towards a payment? Then, develop a strategy for repayment. Below are three helpful strategies for reducing debt and reclaiming financial freedom.
1. The Snowball Method
The snowball method is perhaps the best-known and most straightforward strategy for debt reduction. Focus on paying off your smallest debt first while making the minimum required payments on the others. Once you’ve paid it off, take that payment and apply it to the next smallest debt.
As you gradually pay each debt, you create a “snowball” effect, gaining momentum — and motivation — as your list of debts shrinks. This method is not the most cost-efficient in terms of interest paid since your higher balances are still accumulating interest. Still, it can provide the psychological “wins” you need to keep exercising financial discipline.
2. The Avalanche Method
With this method, you target paying down the debt with the highest interest rate first while making minimum payments on the others. Once you’ve paid it off, move to the one with the next highest rate, working your way down to the lowest.
Focusing on high-interest balances first can reduce the overall cost of debt since you’ll pay less interest over time. But you’ll need to stay motivated to keep chipping away since it may take longer to see those smaller debts vanish.
3. Debt Consolidation
Debt consolidation is a strategy to manage multiple debts by combining them into a single loan. In this case, you’re “simplifying” your debt by reducing the number of payments and creditors. There are three common tools for consolidation:
Personal loans: You take a personal loan to pay off your existing debts.
Balance transfer credit cards: Some credit cards offer a 0% interest rate for an introductory period, allowing you to transfer your existing balances and pay them off interest-free during that time.
Home equity loans or lines of credit (HELOCs): If you own a home, you may be able to use your equity as collateral for a loan to pay off your debts.
Prioritize consolidating the debts with the highest interest rates first. This method only makes sense if you can consolidate at a lower interest rate with a more manageable and shorter repayment schedule. Your credit score will be a factor in the terms available to you.
In more extreme circumstances, two other options may be available.
With a debt management plan, you work with a credit counseling agency that negotiates with creditors on your behalf for reduced interest rates, fees or monthly payments. In turn, you make a single monthly payment to the agency, which then distributes the funds to your creditors. Enrolling in such a plan usually involves a fee, will likely affect your credit score and require you to close existing credit accounts. If you decide to go this route, carefully evaluate potential counseling agencies and preferably select one that is nonprofit and properly accredited.
Debt settlement involves negotiating with creditors, usually with the help of a debt settlement company, to settle your debt for less than the total amount owed. This can be a lengthy process and may not be successful. It can involve a substantial fee to the debt settlement company and severely impact your credit score, which can take years to rebuild.
Each method has its advantages and challenges, and the best approach will depend on your financial situation, preferences and goals, and the types of debt involved.
