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5 Steps to Paying Off Debt and Staying Debt-Free

By Christy Bieber - Aug 27, 2019 at 5:45PM

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Can you really get out of debt and stay out for good? You can if you take these five steps.

Being in debt is expensive, and it can be a big hindrance when you're hoping to accomplish important financial goals. Unfortunately, once you owe money to creditors, it can be really hard to dig your way out of the hole to become debt-free.

The good news is, there are proven steps you can take to retire your debt ASAP and to stay out of debt for good. If you're not sure where to start, here are the five things to consider doing if you hope to pay off what you owe and avoid borrowing again in the future. 

Woman looking at notebook and calculator and doing financial calculations.

Image source: Getty Images.

1. Consider refinancing your debt to a lower rate

If you have high-interest debt, paying it back becomes more challenging because much of your monthly payment simply disappears into the creditor's pocket. It's hard to pay the principal down when a good portion of every payment goes to interest, so lowering your interest rate should be a top priority.

You can reduce the rate you're paying on expensive consumer debt by refinancing. This involves borrowing again at a lower rate and using the proceeds from the new loan to pay off the costly credit. You may be able to get a personal loan to refinance existing debt or a home equity loan that comes with a very low interest rate -- but this puts your home at risk of foreclosure if you can't pay. 

If you have credit card debt, you could also transfer the balance to a balance transfer card. This is a card that offers a special 0% promotional interest rate for a limited time -- often about six to 15 months. 

Once you've refinanced your debt at a lower rate, you can aggressively work on paying down your new loan -- with more of your money going toward reducing the balance each month instead of just enriching creditors. 

2. Decide which debts to pay down early

You need to be strategic about which of your debts you want to make a priority to repay and which you should hang onto. It typically makes little sense to pay off debts with very low interest rates, such as mortgages and federal student loans, since the return on investment for early debt payoff is simply equal to the interest you save. If you pay off a loan at 3.5% ahead of schedule, the maximum return on investment (ROI) is 3.5%, while you could likely score returns of 7% or 8% with reasonably safe investments in stocks.

And if you're getting a tax deduction for mortgage or student loan interest, it makes even less sense to pay off these loans ahead of schedule. A deduction on student loan interest should be available regardless of whether you itemize deductions -- provided your income isn't too high -- while mortgage interest is deductible only for itemizers. 

Credit cards, payday loans, car title loans, personal loans, private student loans, and most other types of consumer debt, often carry high interest rates and no tax deduction to help defray interest costs. Paying these kinds of loans off ASAP is a good idea both so you can stop wasting money on interest and because the return you get on your investment in debt pay-down is often well above what any reasonably safe investments would earn. 

3. Budget for extra payments toward your debt

Paying off debt early won't happen if you don't make more than the minimum payments -- and you can't do this if you don't have spare cash.

The best way to find extra money to send to debt is to make a budget that focuses on paying down debt. Track your spending, figure out areas where you can cut costs, and commit to living on a budget that will allow you to become debt-free in as short of a time as possible.

While you likely won't be able to live on a shoestring budget indefinitely, it makes a lot of sense to make big sacrifices to get your debt paid off quickly. Cutting out dining out and slashing your entertainment budget could allow you to get free of your creditors perhaps years earlier than you otherwise would and you can save thousands on interest in the process. There'll be plenty of time to spend on fun stuff later once you aren't losing a huge chunk of your change to your creditor's balance sheet each month. 

4. Make a strategic plan to pay off what you owe

Once you've got a bare-bones budget that allocates as much spare cash as possible to debt payoff, decide which debt you're going to concentrate on freeing yourself from first. Then, continue sending minimum payments to other creditors while sending as large of a payment as possible to the creditor you're trying to pay off ASAP. 

The best debt to pay off first is the loan that charges the highest interest. That way, you'll be able to limit how long you're paying exorbitant interest costs (debt avalanche). But many people prefer to start with their smallest debt because they want to score a quick victory to stay motivated (debt snowball).

It's up to you which approach you take, but the key is to pick one debt you're aggressively working toward paying off. If you spread your money across all your debts and make small extra payments to each, you won't make progress very quickly and are less likely to stick with your repayment plan. 

5. Live on a budget and maintain an emergency fund 

Once you've become debt-free, you want to make sure you stay that way. You can do this by continuing to live on a budget. While you can allow yourself more leeway than you had while paying down debt, you still need to make sure your dollars are going to the right places. 

You should also prioritize saving an emergency fund with three to six months of living expenses. Your emergency fund will allow you to avoid going into debt when unexpected expenses inevitably crop up. 

You can become debt-free and stay that way if you follow these five steps

When you're looking at a mound of bills, freedom from debt seems like an impossibility. But if you take these five steps, owing creditors can become a thing of the past and you can hold onto your cash to use as you like instead of wasting money on interest every month. Freedom from consumer debt is a key step on the path to financial security, so get started on your debt payoff efforts today. 

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