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The best way to pay off debt: Getting the most out of your money

The debt avalanche method is one of the best ways to become debt-free.

Chris Scott

Contributing Writer at Tally

November 18, 2020

The total average household debt in the United States is $137,729, as of June 2020. 

Carrying debt often harms your credit score, making it difficult to secure future lending. Debt makes it more challenging to handle your day-to-day personal finances and expenses, and it can prevent you from saving for retirement. 

If you want to learn the best way to pay off debt, you've come to the right place. While there is no one-size-fits-all approach to becoming debt-free, there are several steps you can take before selecting a repayment method.

1. Accept reality 

Before you can craft a debt payoff plan, you need to have an honest look at your current financial situation. 

Start by requesting a free copy of your credit report. You are entitled to one free copy of your credit report every 12 months from each of the three free national reporting companies: Experian, Equifax and TransUnion. 

Your credit report shows any open accounts you have and the outstanding balances on those accounts. It also shows things like your credit score and payment history. 

Combine your outstanding balances and determine the total amount of debt you have. Knowing how much debt you have — and where that debt exists — allows you to create a payment plan and pay off your debt. 

2. Set a budget 

Once you know your total debt and the different accounts you need to pay off, you can set a budget to begin paying down your accounts. 

When setting your budget, be sure to continue making minimum payments on your credit cards each month to avoid late payment fees and high penalty interest rates, both of which will further increase the amount of money you owe. 

Along with writing down your total credit card debt, you’ll need to factor in other debt payments such as your mortgage, student loan payments and car loan payments. These are all fixed payments to include in your essential expenses. Even if you have a variable rate on your loans, your lender must notify you at least 120 days prior to the rate change. This should give you adequate time to adjust your budget. 

From there, write down other essentials that you need to live, such as gas, utilities, and food. Calculate how much you spend on these expenses per month. Subtract all of this from your net monthly pay, which is the amount of money you receive in your paycheck after deductions like taxes and health insurance. 

The remaining amount you have is available for flexible spending. 

While you could put this money toward things like dining out or entertainment, it’s recommended to put it toward paying off any outstanding debt. To achieve financial wellness, you’ll want to use most of your flexible funds to pay down your debt. 

3. Earn extra income 

If you calculate your monthly budget and realize you don't have enough money to cover essentials, consider taking on a second part-time job (often called a side hustle). 

Nearly half of people under age of 35 report having a side hustle, and earning a bit of extra money on the side is becoming more commonplace. Even if you earn an extra $100 per week, you'll earn roughly $5,000 more per year. 

This can make a huge dent in your total debt balance, allowing you to pay down your debt faster. 

4. Stop spending on credit 

One of the best ways to pay off debt is by halting all credit card spending. Credit card interest compounds, which means you're charged interest on both your principal and outstanding interest (the total balance). This is one reason why credit card balances can grow so quickly. 

Halting all credit card spending prevents you from taking on new debt, so you can focus on paying down the debt you've already accumulated. Pay for your expenses using cash or debit cards. This limits your purchases to the money that exists in your bank account. 

When possible, you also want to save money for an emergency fund. This fund can cover large, unexpected expenses like: 

  • Medical bills

  • Car repairs

  • Home repairs 

Only 40% of Americans can cover an unexpected expense of $1,000. But having money set aside for emergencies will keep you from putting the expenses on credit, thereby keeping you out of deeper debt. Put this money in a savings account so you're not tempted to use it. 

5. Use the debt avalanche method

The debt avalanche method is one of the most popular ways to pay off debt because it saves you the most money in interest over the long run. 

With this payoff strategy, you use the flexible income from your budget to prioritize paying down the credit card debt with the highest interest rate while continuing to make minimum payments on your other cards. 

For example, let's say you have three credit cards with APRs of 27%, 25% and 20%. After calculating your monthly budget, you realize that you have $200 each month to put toward your debt repayment plan. The minimum payment on each card is $25, meaning you have $125 leftover to put toward debt. You pay $150 to the card with 27% APR and $25 on the cards with the lower APR. 

Once you pay off the card with the highest interest rate, you then move to the card with the second-highest interest rate and continue putting as much money as possible toward that debt payment while making minimum payments on the third card. 

6. Use the debt snowball method 

Another debt management strategy is the snowball method. It's similar to the debt avalanche method. However, instead of using the extra funds in your budget to pay down the debt with the highest interest rate, you pay down the debt with the smallest balance, regardless of the interest rate on the card. 

For example, let's say you have three cards with balances of $1,500, $1,000 and $750. Each has a minimum payment of $25, and you have $200 to put toward debt. You pay $150 to the card with a $700 balance and make minimum payments on the others. 

Once you pay off the card with the smallest debt, you move to the next card until you reach the one with the highest balance. This method allows you to pay off smaller debts and gain momentum — and many people are motivated by the quick wins of paying off an entire card.

However, if you follow the debt snowball method, you may continue to collect high-interest debt. But if you'd rather sacrifice a bit of money in the long-run for some short-term wins that motivate you, this is a useful option. 

7. Use a balance transfer card 

If you have good credit, you may want to consider using a balance transfer card. A balance transfer card is a debt consolidation tool that lets you move your credit card balances onto a single card. 

There is a balance transfer fee, which is typically 3% to 5% of the total balance transferred. But if the fee is less than your current APR, it’s likely a price worth paying. 

Once your existing balances are moved to the balance transfer credit card, you have a fixed amount of time to pay off the outstanding balance with 0% APR. This gives you time to pay down debt without collecting interest. Be sure to read the terms of agreement before applying for this type of credit card because, eventually, the 0% APR offer will end.

8. Use a credit card payoff app

Another option for those with good credit is to use a credit card payoff app like Tally. Tally gives you a low-interest line of credit and uses it to automate your credit card payments in the most strategic and efficient way possible. 

Tally follows the debt avalanche approach to save you the most money possible, focusing on debts with the high interest rates first.

You don't need to worry about making payments each month to multiple credit cards since Tally does it for you. You only need to make a single monthly payment to Tally. It’s an effective option to reach your financial goals sooner. 

Start paying down debt today 

Whether you carry credit card debt or student loan debt with fixed payments, owing money can be stressful. Figuring out how to pay off your debt can be even more intimidating. 

But getting started is easier than you think. Evaluate your financial situation and set a budget so you know how much you can pay back each month. If it’s not much, consider taking on a side hustle if you need the extra money. 

Once you have enough flexible income, you can start paying off your debt. The best way to pay off debt is with the debt avalanche method, which targets your high-interest debts. If you have good credit, consider using a balance transfer card or a credit card payoff app like Tally.