How to Get Out of Debt in 2020: 7 Strategies That Work - The Motley Fool

In our current low-interest rate environment, mortgages and many car loans can be very manageable. Other debts are far more problematic, though, such as high-interest rate debt tied to credit card companies, along with student loan debt, which is crushing many young and even middle-aged people.

You won't become debt-free anytime soon making minimum payments, but there are some powerful ways to get out of debt. Here's a review of how you might do so, featuring the following topics:

• You're not alone
• Why it's critical to get out of debt
• You can get out of big debt -- many others have
• Assess your financial condition and determine your net worth
• Meet your credit score
• Have goals
• Employ a smart strategy
• Strategy No. 1: Negotiate lower rates
• Strategy No. 2: The snowball approach
• Strategy No. 3: Pay off costliest debts first
• Strategy No. 4: Consolidate debts
• Strategy No. 5: Look into balance transfers
• Strategy No. 6: Spend less and earn more
• Strategy No. 7: Avoid dumb mistakes

Image source: Getty Images.

You're not alone

Thinking about all the debt you may be carrying can be stressful, but take some comfort in the fact that you're not alone. According to TheAscent.com, as of about a year ago, the average credit card debt per card holder was $6,028. The 2018 Consumer Financial Literacy Survey found that 38% of respondents were in households carrying debt from month to month -- though only 13% of them owed $5,000 or more.

Meanwhile, the average student loan debt per borrower recently was $29,200, according to the Institute for College Access and Success -- with many of those debtors still quite young and not earning all that much.

Why it's critical to get out of debt

You probably know that it's important to get out of (high-interest rate) debt, but if you haven't thought about just why it's vital to do so, you may put off taking action. So here are some compelling reasons to get out of debt:

• Debt is stressful. About 54% of those aged 39 to 54 reported carrying credit card debt, per a 2019 Morning Consult/Insider survey, and two thirds of them were stressed out by it. Stress, meanwhile, is a problem itself, as it can lead to poor health, depression, anxiety, and more.
• It's hard to reach any financial goals, such as a down payment on a home, putting a kid through college, or even buying a nice new car, if you're saddled with debt. Whatever you're paying each month toward debt -- $500, $1,000, more... -- could instead be going toward much more appealing goals.
• Debt is more costly than most people realize. Do the math: If you owe, say, $15,000, and you're paying 20% interest, that's $3,000 going to interest alone each year, leaving you with little to show for it. Imagine what $3,000 per year could do for you if invested. Over 20 years, for example, if it was invested in stocks and grew at 8% annually, it would become about $14,000!
• Carrying too much debt can leave you with a low credit score, which will keep lenders from offering you good interest rates when you want to take out a mortgage or other loan, and can keep you from qualifying for the best credit cards, too.

You can get out of big debt -- many others have

The thought of digging out from debt -- especially if you're carrying a lot of it -- can be daunting. You may think that you just can't do it and that bankruptcy is your only option, but guess what -- you can get out of debt. Gobs of people have done it before you, and some of them were paying off massive balances of more than $100,000!

The more you owe, the more you'll need to have a solid, detailed, aggressive plan -- and you'll probably need to stick to it for at least a year or two. Keep reading to learn key steps you should take.

Assess your financial condition and determine your net worth

Start with getting a good handle on just what your financial condition is. Grab a notebook and start making lists. List your income, from all sources. List your debts, too -- all of them. Include how much you owe in total, what your monthly payments are, and what interest rate is associated with each debt.

It's good to also list your assets, which include all kinds of things that have value, such as your cash in the bank, your investment accounts, the equity you have built in your home, and property such as your cars, your bikes, furniture, and collections of clothing, books, music, board games, puzzles, art, wines, and so on. Add all your assets together and subtract your total debts from your total assets. What's left is your net worth. Ideally, it will be a large, positive number. But it won't be if you're being crushed by debt. So once you get out of debt, you can work on building your net worth. (By the way, the average American household had an average net worth of close to $700,000, per the Federal Reserve's 2016 Survey of Consumer Finances.)

Image source: Getty Images.

Meet your credit score

We all should regularly review our credit records and know our credit scores -- because credit scores count for a lot in American life, affecting how much you're charged to borrow money, among other things. Your credit score is based on data from your credit record, which features reporting on all your debts (home loans, car loans, credit card debts, etc.) and your money management -- such as how regularly you make your payments on time.

Take a look at the table below, which shows the kind of interest rates being offered to people with different credit scores if they're borrowing $200,000 via a 30-year fixed-rate mortgage:

FICO Score	APR	Monthly Payment	Total Interest Paid
760-850	3.366%	$883	$117,951
700-759	3.588%	$908	$126,859
680-699	3.765%	$928	$134,056
660-679	3.979%	$952	$142,862
640-659	4.409%	$1,003	$160,931
620-639	4.955%	$1,068	$184,534

Source: MyFICO.com, as of January 4, 2020.

Those little percentage-point differences can seem minor, but they translate into big differences over time: Indeed, the difference in total interest paid for someone with a great FICO score and someone with a bad one can be more than $66,000 for a $200,000 loan (and much more if you're borrowing more).

It's worth checking your credit score from time to time to make sure nothing surprising is happening with it. (Many credit card companies offer free access to your score.) As you're paying your debts off, your score should rise, which can give you a great motivating boost. Here are the components of the widely used FICO score:

Component of Credit Score	Influence on Credit Score
Payment history	35%
How much you owe	30%
Length of credit history	15%
New credit	10%
Other factors such as your credit mix	10%

Source: myFICO.com. 

You're entitled to a free copy of your credit report annually from each of the three main credit agencies -- visit AnnualCreditReport.com to order yours. Fixing errors is one of many ways to increase your credit score.

Have goals

Before you proceed to start paying off your debts, it's helpful to have some concrete goals that can serve as needed motivation. What kind of goals? Well, several:

• Big financial goals: Be inspired to keep plugging away at your debt by the thought of financial goals you want to attain, such as that down payment on a nice home, that home theater you want to build, that 'round-the-world trip you want to take, and/or the money you need to retire with.
• Debt-reduction goals: Don't just think of debt as a single huge sum to pay off. Instead, separate it into manageable chunks that you'll retire over time. If you owe $25,000, for example, you might plan to pay off $15,000 of it in the coming year and the last $10,000 in the following year. Even those chunks might be broken down further, perhaps into $800 to $1,200 per month.
• Credit-score goals: Take note of what your credit score is now, and decide what you'd like it to be. You might then create a chart or graph, where you track your progress toward that goal over time.

Have a good strategy that will work for you. Image source: Getty Images.

Employ a smart strategy

Now it's time to start thinking of just how you're going to pay off your high-interest rate debts. There are lots of possible strategies, and we'll review a handful of the most popular and powerful ones below. See which ones make the most sense for you to employ.

Strategy No. 1: Negotiate lower rates

In general, it takes a lot of effort and perseverance to pay off debt, and it can take a lot of time, too. But this strategy takes less than an hour: Make some phone calls to your lenders and ask them if they'll lower your interest rate.

Mortgage debt is probably not a problem, but even there you might save a lot of money by refinancing -- if you can get a new interest rate that's about a percentage point lower than your current one and if you plan to stay in the home for a bunch more years.

Credit card debt, though, is often being charged interest rates in the mid- to high teens, if not in the 20% to 30% range. If you've been a good and, ideally, long-term customer, you stand a decent chance of getting your rate lowered just by asking. Fully 68% of those who asked their lenders for a lower rate got one, according to one report.

Strategy No. 2: The snowball approach

There's a good chance you have multiple debts, with different sums owed at different interest rates, The snowball approach aims to have you feeling like you're making a lot of progress as you knock down debt after debt, so it has you paying off your smallest debts first, and ending with your largest debt. Imagine having the following debts:

Debt	Sum Owed	Interest Rate
Car loan	$15,000	4.5%
Credit Card A	$5,000	16%
Credit Card B	$8,000	20%
Credit Card C	$6,000	18%
Mortgage	$180,000	4.2%

Source: Author.

With the snowball approach, you'd pay off the smallest debt, for Credit Card A, first, followed by Credit Card C, Credit Card A, and then your car loan.

Strategy No. 3: Pay off costliest debts first

The snowball strategy may be more satisfying, as it lets you retire debts as quickly as possible, but it's not the most efficient. Look at the table above, for example, and you'll see that Credit Card B is charging you the highest interest rate. It makes a lot of sense to pay that debt off first, and then to tackle Credit Card C's debt, as it's the next-highest. The higher the interest rate, the more money you'll be forking over in interest, so it's very rational to retire your costliest debts first, leaving your lowest-interest rate debts for last.

Strategy No. 4: Consolidate debts

Another option is to consolidate all or most of your debts, creating a big ball of debt. Why? Well, it can be easier to keep track of that single big debt, instead of trying to manage multiple debts to multiple lenders. You probably can't roll every single debt into one big debt, but you may be able to do so with all your credit card debts, and it's possible to consolidate many student loans, as well. Here are some ways to go about it:

• Consider taking out a home equity loan to pay off debts. Only do this if you're being offered a lower interest rate for the new debt, and understand that this strategy has some drawbacks. For example, you'll be putting your home at risk if you don't make the payments, and if you borrow a lot, you might end up underwater on your loan, if the home's value falls below what you owe on it. In such a situation, selling the home would still leave you in debt.
• You might consolidate federal student loans into one loan, such as via the Department of Education's Direct Consolidation Loans. (This is often referred to as refinancing student loans.) Read up on the drawbacks, too.
• You could take out a personal or private loan to pay off debts. Be sure to run the numbers first, though, making sure you'll come out ahead. If you'll face a steep interest rate or fees, it may not be worth it.
• You could make use of balance transfer cards, which we'll review soon.

Consolidation isn't a no-brainer move -- here are its pros and cons:

Pros:

• You may end up with lower total payments, especially if you extend your repayment period.
• You can get out of default.
• You can switch to a lender you prefer.

Cons:

• You may end up with a longer repayment period, which means you'll be in debt longer (unless you can make extra payments) and will likely pay more in interest.
• You may lose some flexibility, having just one big debt instead of many smaller ones, with different terms.

Strategy No. 5: Look into balance transfers

Interestingly, one strategy to get out of credit card debt is to use... credit cards. Specifically, good balance-transfer cards. With one, you transfer debt to it from another card or cards, and you generally get a very low initial interest rate -- often 0% -- for a specified period of time. It's common for the initial rate to last between six and 21 months. After that, the card's regular rate will apply, and that regular rate may not be much better than your current rate(s), and could even be higher. So if you go this route, aim to get that debt paid off within your initial grace period.

When shopping for a balance-transfer card, look for a generous grace period, and relatively low standard interest rates. Also consider the balance-transfer fee, if there is one. It's common to be charged between about 3% and 5% of the amount you're transferring. That can amount to a meaningful sum, but it can still be worth it.

If you're not sure that you'll be able to get your debt paid off during the grace period, consider going with a low-interest rate credit card instead -- but then do still try to pay off that debt as soon as you can.

Be sure to read the fine print and detailed terms of any new credit card you're going to use. With a balance-transfer card, for example, find out what the credit limit will be, as you won't be able to transfer more than that. Find out if you'll be charged any fees if you exceed the limit. And find out if there's a penalty APR, too. That's when the card company suddenly increases your interest rate to 25% or even 30% if you pay a bill late or commit some other transgression. Many cards don't feature them.

Image source: Getty Images.

Strategy No. 6: Spend less and/or earn more

This strategy may seem obvious, but some people don't give it enough consideration: Simply spending less and/or earning more can leave you with a lot more money that can be applied to debt reduction. Some may not be appealing, but you may be able to endure them for up to a year or two in order to get back into good financial health and begin working toward other goals.

Here are some ways to spend less:

• Brown-bag lunches and make your own coffee in the morning.
• Negotiate lower charges from your cable TV company.
• Cut the cable cord and streaming your entertainment instead.
• Stop subscriptions such as gym memberships.
• Aim to spend less at restaurants. Only buy what's on your shopping list.
• Don't go to malls and stores for entertainment or out of boredom.
• Eat at restaurants less often.
• Drink water when eating out, as drinks can be costly, and those costs can add up.
• Have friends over to play games, do puzzles, or watch movies instead of going out.
• Put off non-critical major purchases, such as a new large-screen TV or refrigerator.
• Shop with coupons in stores and coupon codes online.
• Trade babysitting services with friends.
• Quit smoking.

Here are some ways to make more money:

• Take on a part-time job. Working 10 more hours a week for a year at $12 per hour can get you $6,000 annually, pre-tax.
• Consider working at a local retailer or at home, perhaps tutoring students, teaching music, doing freelance writing or editing, or consulting.
• If your household has two or more cars, consider whether you could sell one and get by for a while.
• Clear out clutter in your basement, attic, and/or garage by selling items.
• If you have the skills, consider making and selling things, such as jewelry, soap, knitting, woodworking, and so on.
• Depending on where you live, you might be able to rent out space in your home via services such as Airbnb.com or VRBO.com.
• You might drive for a ride-sharing service such as Uber or Lyft. Or deliver meals via services such as GrubHub or DoorDash.
• Be a dog-walker or pet-sitter.
• Ask for a raise: According to one report, roughly 70% of those who ask get one.

Strategy No. 7: Avoid dumb mistakes

A final strategy is simply to avoid dumb moves that can set you back further. For example, be sure to not sign up for a credit card with a "penalty APR" feature, unless you know you're not going to end up carrying debt that it's suddenly charging you 25% on.

Don't assume you'll eventually get out of debt by just making minimum payments, either. That can be deadly. For example, if you owe $20,000 on a card that's charging you 20%, and you only make 4% minimum payments on it, it will take you more than 16 years to pay it off, and you'll be paying a total of more than $34,000! That means interest alone will cost you more than $6,000, which is more than you owed in the first place. Ouch.

Credit card debt and other high-interest rate debts can be debilitating, but here's the good news: They don't have to be permanent. Yes, you may be feeling the burden of them now, but if you work hard at it for a year or two, you may find yourself free of it and able to start building serious net worth sooner than you expected.

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