How to Pay Off Debt

The Federal Reserve’s Q2 2024 report on household debt and credit highlights the ongoing challenges Americans in debt face. Aggregate debt balances on mortgages, home equity lines of credit (HELOCs), credit cards, and auto loans continue to rise. This rising debt presents a barrier to creating financial stability and, in turn, the freedom to enjoy the funds you work so hard to get.

The good news is there are many approaches to paying off debt that can help ease the burden. In this article, we’ll explore three key steps to consider when paying down debt.

Key considerations

• Paying off debt is a long-term commitment that can take months, years, or decades, depending on the amount of debt you have, the interest rates, and payment terms.
• Strategies like the debt snowball, debt avalanche, and debt consolidation can help you systematically pay off debt.
• Understanding troublesome financial habits may help you make long-term changes to get out and stay out of debt for good.

Calculate your total debt burden

Before you develop a plan to get out of debt, it’s important to understand exactly how much you owe. Create a list of each debt you have and note:
 

• The lender or creditor that holds the debt
• The current balance
• The interest rate
• Whether the interest rate is fixed or variable
• Whether the debt is secured with collateral (mortgage, auto loan) or unsecured (credit cards, student loans)
• The monthly payment due date

Organizing your debts into a list can provide clarity on their scope and help you determine the most effective repayment strategy. A key way to assess how manageable your debt is involves calculating your debt-to-income (DTI) ratio. Your DTI ratio considers how much you’re paying toward debt as a percentage of your gross monthly income.

A DTI ratio of less than 40% is typically considered manageable, while anything over 50% indicates an inability to take on more debt and potential problems managing existing debt. Since lenders will review your DTI ratio before offering you a loan, it’s a critical figure to know before you apply for financing.

With a complete list of your debt and your DTI ratio in mind, you can begin to think about a realistic strategy to repay what you owe.

Choose an effective debt repayment strategy

There are three main debt repayment strategies that may be worth considering depending on your debt burden and financial goals.

Debt consolidation

Debt consolidation is a tactic to shift multiple high-interest debts into one loan with a single monthly payment. For well-qualified borrowers, a debt consolidation loan offers a lower interest rate, which can save you money on interest while streamlining debt management. You might consider consolidating debt if you have a lot of unsecured debt, like credit cards, for more manageable monthly payments.

The snowball method

With the debt snowball, you’ll pay off your smallest debt first, regardless of interest rate, while continuing to make minimum payments on all other debt. Then, once that debt is paid off, roll the money you were putting toward it into the second lowest balance debt. The idea here is to create momentum, like rolling a snowball down a hill that will inevitably gain weight and speed as it goes. Ideally, your motivation will build after repaying the first debt, and you will be encouraged to continue until your largest debt has been paid in full.

The avalanche method

With the avalanche method, you start with the highest interest debt first, regardless of balance, while continuing to make minimum payments on all other debt. Similar to the snowball method, once the debt is paid, you’ll roll the payment you were making into the debt with the second highest interest rate. The avalanche method is a way to maximize interest savings since you’ll be rid of the highest-interest debt first.

The best way to pay off debt is by choosing a strategy you can commit to following for the long term or until your debts are paid. If you’re someone who relies on quick wins to stay motivated, the debt snowball may be the better choice. However, if you’re motivated by saving money, a debt consolidation loan or the debt avalanche might be a better fit.

Change your money habits to stay out of debt

After committing to repaying your debt, it’s important to adjust your spending habits to avoid accumulating more debt. There are several helpful changes in habit you can implement, including:
 

• Spend according to a budget: While some might see a budget as restrictive, it’s a way to set clear boundaries around your spending. The key is to be honest with yourself when creating a budget, particularly in areas where adjustments are needed. Small, realistic changes are often easier to manage and maintain compared to drastic ones, making it simpler to gradually shift your spending habits.
• Prioritize spending categories: Identify the categories that matter most to you and allocate more of your budget there, while cutting back in other areas. For instance, if dining out is a priority, you might set aside extra funds for restaurants and adjust by reducing your clothing or travel budget. By aligning your spending with your priorities, you can enhance your satisfaction with the purchases you make.
• Set a mandatory cooling-off period on purchases: To reduce impulse spending, set a mandatory wait time before making purchases over a certain amount, such as $100. For example, you could wait 24 hours before deciding to buy. This pause gives you time to consider whether the purchase is truly necessary, often helping you realize you may not need it after all.
• Delete your credit card number from shopping apps and websites: One-click ordering is the enemy of good spending habits. Try removing your card number from your favorite shopping apps and websites so that you have to physically type in the card number every time. It might surprise you how much this helps you avoid impulse buys.

Big, sweeping changes like consolidating debt, can be impactful when you’re getting out of debt. But small, steady habit changes can also have a big impact over time. The most important thing is that you start to take steps to get out of debt, leveraging financial tools and education at every stage.

How BHG Financial can support you in your debt payoff journey

BHG Financial offers debt consolidation loans of up to $200,000¹ with loan terms of up to 10 years^1,2 to help you streamline high-interest debt repayment. Start today by contacting our dedicated concierge support team or checking your rate online with no cost, commitment, or impact on your personal credit score.³