4 Helpful Tips for Paying Off Debt

With student loans, credit cards, and your car loan, among others, you may feel like you have a never-ending list of debts. How could you possibly repay them all on your meager salary?

Here are four tips for paying off debt aimed specifically at 20- and 30-somethings who might not be making the big bucks yet, but who are certainly facing big bills. Sound like you? Read on.

1. Choose a Strategy

Finance experts who issue tips for paying off debt often recommend one of two strategies:

1. Debt stacking: Rank your debts based on interest, from highest to lowest. Make the minimum payment on every loan, then throw every spare dime at your highest-interest debt. Based purely on mathematics, this will (theoretically) save you the most money on interest.
2. Debt snowball: Rank your debts based on balance, from smallest to largest. Make the minimum payment on every loan, and pay extra on the loan with the smallest balance. You’ll soon wipe that loan off your list, which gives you a psychological victory that keeps you motivated. Sure, this isn’t the most mathematically sound strategy, but it may be the most emotionally gratifying one.

Which is the better option? The one you’ll actually stick with. Pick your favorite, and don’t worry if you like the option that’s not mathematically ideal. “Done” is better than “perfect.”

2. Don’t Take on New Debts

Your car is a 17-year-old beater, and you’ve just discovered it needs an $800 repair (about half of the car’s value). You’d love to replace it with another one, but there’s no way you could pay cash for a car. You’ll need to take out a loan. Should you add this to your long list of other debts?

Nope. The only way to achieve debt freedom is by not piling on new debts. That may mean you’ll need to drive an old car for a few more years (or live in a walkable neighborhood if you can’t afford the repairs), stop dining at restaurants and buying clothes, or live in a small apartment. That’s OK. The ultimate goal—a debt-free lifestyle—is worth the trade-off.

One possible exception to the no-new-debts rule? Taking out a small, reasonable mortgage. This might be acceptable in some circumstances because it could decrease your monthly living expenses and free up more cash for other debts.

3. Create an Emergency Fund

Before you begin making extra payments on your debts (beyond the minimum required payments), create a small emergency fund of $1,000. This is enough money to tide you over in case of most genuine emergencies—your car breaks down, your refrigerator stops running, you overdraft an account, or another unforeseen event occurs.

Why bother saving while you’re in debt? If something goes wrong, a small rainy-day fund is insurance against creating new debts. Furthermore, creating a such a fund helps you learn the habit of falling back on your cash reserves rather than looking to loans to bail you out of a jam.

After you’ve repaid the rest of your debt, you can build a bigger emergency fund (around three to six months of expenses). It’s smart to start small and then work your way up.

4. Save for Other Goals

Divide your savings into two piles: money toward debt, and money toward new goals like a car, home, or wedding. Then figure out how you want to slice the pie.

You could split your savings 50/50, with half for extra debt payments and the other half for future savings. Or, you could aggressively repay your debt with a 70/30 or 80/20 split. Splitting your savings between the past (debt) and the future (goals) allows you to maintain a healthy balance.

Setting a budget, and then really staying true to it, is a vital component of life. Making a plan to both get out of debt and save for your future will give you security now and a leg up on whatever is important to accomplish down the line.

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