How to create a debt repayment plan

If you’re working to eliminate debt, you’re not alone. The average American now has more than $90,000 in debt, including credit cards, student loans and mortgages.1

Not all debt is a bad thing; mortgages and student loans, for example, help you invest in yourself and your future. But endless payments and ever-increasing interest could prevent you from achieving other goals, such as saving for retirement or investing in the markets.

The following steps can help you create a plan to pay off your debt and take control of your finances.

Create a spreadsheet that lists all your loans and credit cards, their balances, monthly payments, and interest rates. Include both unsecured debt (which is not secured by property, such as credit card or medical debt) and secured debt (which is secured by property, such as a mortgage or car loan).

Getting a clear picture of the exact amount you owe, and may owe in the future, in interest is the first step to getting your debt under control.

There are two popular methods for repaying debt: the snowball method and the avalanche method. Everyone has a different philosophy of which debt to pay off first.

Debt Snowball: Under this method, you make minimum payments on all of your debts and then dedicate additional funds to paying down balances, from smallest to largest. The idea behind this strategy is that quick success paying off small balances gives you the momentum and motivation to tackle bigger ones. The downside is that you don’t necessarily prioritize high-interest debt, and the interest charges incurred on that debt could be costly.

Avalanche of debt: With this approach, you eliminate the debt according to the interest rate, from highest to lowest. Essentially, you prioritize the debt that is costing you the most, regardless of the balance. The downside here is that it may be harder to stay motivated if your most expensive debt has a high balance, as it may take you longer to see results from your efforts.

Is one method better than the other? It’s subjective and depends on your goals. If saving interest is your priority, Debt Avalanche might be a better bet. For those who enjoy the boost that can come from completing small tasks, the debt snowball might be the preferable option.

You can also get the best of both worlds by combining the two strategies; for example, first pay off your debt at the highest interest rate to save, then switch to the lowest balance to maintain momentum.

If keeping up with multiple monthly payments becomes unmanageable, or if high interest charges make it difficult to pay off your balances, debt consolidation or refinancing may be worth exploring.

Consolidation involves borrowing a lump sum to pay off your debt, thereby combining multiple balances into one. Refinancing involves using a new loan or line of credit to pay off existing debt while changing the terms of the contract in some way, such as lowering the interest rate.2

These methods have their advantages, but be aware that a request for debt consolidation or refinancing could trigger a thorough investigation of your credit file, resulting in the loss of certain credit points. That said, the impact on credit scores varies. Someone with a limited credit history might see a greater impact from further investigation than someone with a long credit history.3 Depending on your goals, the temporary drop in credit score may be worth the convenience or savings that come with debt consolidation or refinancing.

After documenting, prioritizing, and structuring your debt, consider setting up automated payments. Because debt repayments happen automatically, you won’t have to remember to make each one, and you can rest assured that they’re done on time.

The benefits of this are twofold: making regular payments will reduce your balances, and paying on time can help you build a positive credit history. Of course, you’ll need to make sure you keep enough funds in your account to avoid overdraft issues.

Developing a plan for your debt allows you to better control your balances. List your debts to see where you stand, prioritize your repayment goals, and consider restructuring to make it easier to manage.

Finally, if paying off debt becomes a burden, don’t be afraid to ask for help. There are plenty of debt counseling services out there, and financial professionals can discuss the strategies available to reduce — and possibly eliminate — your balances.

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