How To Pay Off Your Debt While Living Paycheck-To-Paycheck
We know the importance of paying off debt. But we also know it can be hard. And it can be particularly hard when you're living paycheck-to-paycheck and have little flexibility in your budget.
Most advice on paying down debt boils down to "pay as much extra as you can towards the debt each month." But what happens when you barely have enough for necessities?
Work + Money talked to personal finance experts for tips on what to do when making-ends-meet is in direct conflict with ending your debt.
The bad news? There's no easy fix and most every financial advisor we spoke with told us that paying off big credit card balances and student loans sooner rather than later is going to take some sacrifice and make you a little uncomfortable.
And they also told us you need to start right now: don't wait for that raise or better-paying job that may or may not come at some point in the future. If it comes, great: you're ahead of the game. But if it doesn’t come, it's still possible to live debt free.
And here's the good news: the financial advisers had tips and tricks for attacking your debt sensibly that can reduce the amount of time it will take you to be debt-free. The other bit of good news is that none of them reported having clients who regretted the sacrifices they made once they were debt free.
Start an Emergency Fund Before You Start Paying Off Debt
The old rule of thumb was that, given high interest rates on debt and low interest rates on savings accounts, you should pay off debt before you start saving.
But Ellie Thompson, the CEO of Money Therapy, says those steps should be reversed. Pay the minimum balance on your credit cards, but then put extra money to a savings account and don’t worry about aggressively paying off debt until that savings account hits $1,000, she said.
"Why? So you can pay cash for your unexpected expense instead of reaching for your credit card and furthering yourself in debt," Thompson said. "You can start with small amounts — even $25 a month can make a difference."
Use a Debt Snowball or Debt Avalanche
Rob Drury, executive director of the Association of Christian Financial Advisors, says a lot of people find they make progress when they implement a "debt snowball" plan to pay off debt.
In a debt snowball, people budget a certain amount each month to pay off debt. They pay the minimum balance on each credit card, excepts for the one with the lowest balance, where they pay off as much as they can afford in their monthly budget.
"Once that account is paid off, move on to the next smallest, and so on. This is so that one is motivated by the rapid initial progress, making it easier to maintain that momentum," Drury said. "Others suggest concentrating on the highest interest rate account, the 'debt avalanche' method, because this makes a greater mathematical impact. Mathematically, the difference is usually relatively minimal."
Drury said: "Bottom line: Do whichever works and feels the best, and don't quit until the debt is gone."
The Level Pay Strategy
If you can only afford to make your minimum monthly payments, the Debt Snowball and Debt Avalanche won’t work for you. So Todd Christensen, author of "Everyday Money for Everyday People," recommends a strategy he calls "level pay."
"Turn this month’s minimum payment into your permanent monthly payment — assuming you do not use the card again — even as the requested minimum payment goes down each month," he said.
If you only pay the minimum monthly due — which decreases as your outstanding balance decreases — it can take 20 years to pay off a credit card.
Using Christensen's "level pay," that time can drop to six or seven years.
Ask for a Raise
Jennifer McDermott of the personal finance comparison site finder.com notes that the national average for annual salary increases is 3 percent. It can't ask for an earlier review or a bigger increase and then use that extra money to pay down debt.
"If you are already on a low salary, this might not equate to much additional income each month, but that is extra funds that you didn’t previously have. Using that to put towards your debt will help you pay it off faster and save a ton on interest," McDermott said.
The key, of course, is making sure that extra money in your paycheck goes to paying off debt. Set up autopayments from your bank account as soon as you see the raise has been processed in your pay stub and continue to live on the budget you had before you got your pay hike.
Cut Expenses Everywhere You Can
Making some drastic cuts to your budget in the short term means you will pay off your debt quicker and get back to living a more comfortable lifestyle. McDermott recommends asking some tough questions about your current budget.
"Could your rent be decreased by taking on another roommate, even if temporarily, moving in with your parents or moving to a cheaper neighborhood? Look at whether you need your car, which is eating up a lot of money in maintenance and gas, or if you can manage transportation while paying down debt," she said.
Providing you are being honest with yourself, you may not like the answers to these questions. But the more you can do to throw every available dollar at your debt, the better.
Where Should You Cut Expenses?
Christensen has a strategy he calls "Power Cash" for helping people to determine where they can make cuts. And the short answer is "everywhere."
"Take 10 percent of certain household discretionary expenses — groceries, gift giving, dining out, entertainment, travel — and add it to the minimum payment," he said. "Most households will find that they can still eat well on 90 percent of their previous grocery budget, freeing up $40 to $60 a month to accelerate debt repayment."
According to Christensen, those small cuts have a huge impact: debt that would have taken 20 years to repay with minimum monthly payments can reduce repayment time to as little as three years.
That Netflix Subscription Is 'Only' Costing $11 a Month. Or Is It?
We tend to look at the per month or even the per day cost of things. Yes, somewhere in the back of our heads we know that Netflix is actually costing $132 per year, and the daily stop at Starbucks — which is "only" $4 a day — is actually $20 a work week or $1,000 a year.
But look at it another way. Let's say you canceled Netflix today and instead sent that extra $11 to your credit card company. Assuming you have the average annual interest rate of 15 percent, that $11 payment today is going to save you $1.65 in interest payments over the course of the next year. So Netflix, in a sense, is actually costing you closer to $13 a month, or $156 per year.
Yes, we're hitting on the "cut expenses everywhere you can" theme pretty hard. But it's literally the only, truly effective way to cut debt faster.
Stick to Your Budget
The number one reason people fall off a debt repayment plan is they fail to budget, or they fail to stick to a budget. A number of the financial experts we spoke with recommended using cash for spending.
Once the cash is gone, you're done spending for the week, and you need to have the discipline not to tap into your bank account or, even worse, put extra purchases on the credit cards you're working so hard to pay down.
One strategy is the "envelope method." In this strategy, you put cash in an envelope for each category of expenses on each payday. For examples, you may have envelopes for clothes, groceries, dining out and random spending. By separating money into piles, you're forcing yourself to think before you, say, overspend on a dinner out.
Don't Sell Your Stuff
A lot of people think it makes sense to sell as much of their stuff as they can to accelerate debt repayment. And that makes sense for some things, like that guitar you bought on eBay that you're finally old enough to admit you're never going to learn to play.
But you shouldn't sell everything, especially stuff you will eventually need to replace.
The reason is you're likely to have to discount the sales price on those items by as much as 90 percent of what it's going to cost to replace them (there's a reason why pawn shops never seem to go out of business).
The last thing you want to do is get out of debt, only to rack up big credit card bills trying to replace all the stuff you got rid of to pay down your debt.
Make More Money
This seems obvious, but a lot of people assume they are making as much money as they possibly can.
The key thing to remember is that earning even as little as an extra $50 or $100 a month to apply towards your debt payments can speed up the process.
That extra $100 a month can come from a wide-range of sources. Would your boss give you an extra $25 a week to keep you from taking a job you might not like as much but feel you have to take because of its higher pay? If a raise is out of the question, is overtime available? Are there side jobs you can pick up that will be flexible enough to work with your full-time job's schedule?
Bankruptcy vs. Debt Counseling
If you get to the point where you can’t keep up with payments and your credit score is taking a beating, it's time to consider a drastic step. For most people, the first step will be debt counseling. Debt counseling companies negotiate lower balances with credit card companies and relaxed repayment terms.
But that may be a wasted step, as a lot of people who try debt counseling ultimately delay the inevitable move to file for bankruptcy, according to New Jersey bankruptcy attorney Ronald I. LeVine.
"When someone is in a position where assistance is necessary to pay off debt, they should look first at the national debt relief law, the Bankruptcy Code," LeVine said. "It is set up to give most folks a fresh start without any further payments to creditors."
He said, "Debt settlement is touted by companies that work in that field, but fail to advise that the completion rate is almost zero and that any debt forgiveness is taxable income. Actually, debt settlement is so fraught with conflicts that it is a crime in NJ to engage in except for certain limited circumstances."