How to Pay Off Debt

Paying off debt can seem overwhelming, especially when the payments start to become too much for your income. Juggling bills, putting off payments and dodging collectors is all extremely stressful. And financial stress has a way of completely taking over your thoughts, so it’s hard to focus on anything else. Luckily, you’re in the right place to learn how to pay off debt in the fastest way possible.

Are you cuffed to a large debt load and need a plan to pay off debt?Here’s a quick overview on how to pay off debt effectively:

  1. Prioritize your debts for repayment, based on urgency
  2. Define your goals for debt repayment
  3. Identify solutions that fit your goals
  4. Implement those solutions and set a budget
  5. Set milestones that help prevent further financial hardship
  6. Keep an eye on your credit along the way

Step 1: Prioritize debts for repayment

The first step to making an effective debt repayment plan is to know where you stand. When debt problems get bad, people tend to start avoiding them. As a result, you may not even know how much you really owe.

Make a table like the one you see below to get started.

  • You should be able to find balance and APR on your most recent statement.
  • Status refers to whether the debt is current, behind or charged off in collections
  • Notes can include anything useful that you think may affect repayment; for instance, if you believe a federal student loan debt will qualify for forbearance or deferment
DebtCurrent BalanceAPRStatusNotes

Now you can start prioritizing the debts for repayment, based on the urgency of repayment. Essentially, you want to pay off high interest rate debt first because they cost more money over time. But you also need to consider things like risk of default or the ability to delay payment.

Here are some tips to help you prioritize:

  • Higher APR (interest rate) increases the priority for repayment.
  • Debts that can cause things like wage garnishment should be given the highest priority, like tax debt and federal student loans.
  • Old debts that are close to the statute of limitations should be given low priority.
  • Large, fixed-rate installment loans (like your mortgage) should be last.

It’s important to recognize that low priority doesn’t mean you won’t do anything to make the debt easier to repay. It just won’t be at the top of the list to eliminate first. But this prioritization will help you identify the worst “pain points” that you need to address first.

Step 2: Define your goals for debt repayment

Review your debts carefully to find the best way to get out of debtFinding the right debt solutions often involves defining what you really need to accomplish. The solutions you use to achieve the fastest repayment possible are usually not the same solutions you use when you need lower payments. This means that you need to define what your goals are before you start looking for solutions.

To do this, rate the importance of the following:

  • Lower monthly payments
  • Fast repayment
  • Lower total cost
  • No credit damage

Step 3: Identify solutions that fit your goals

Now that you know where you are and what you want to accomplish, you can start looking for solutions. Keep in mind that no two situations with debt are identical. So, what worked for your friend or family member may not work for you.

Also keep in mind that if you have more than one type of debt, you’ll probably need more than one solution to pay it off effectively. Different types of debt must usually be kept separate. So, if you have credit card debt and student loans, you’ll need at least two repayment strategies to solve your problem.

In some cases, you may use more than one solution for the same type of debt. For instance, if you have federal and private student loans, you may want one solution for federal and another for private. If you have one credit card that’s behind but the others are in good standing, you may settle that debt and use consolidation for the others.

Talk to a certified consumer credit counselor today for an expert opinion on your best option to get out of debt.

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Here’s a basic overview of various debt solutions that are commonly used for different types of debt:

Credit Card Debt

  • If you have less than $5,000 to pay off and good credit, use a balance transfer
  • For a larger balance (less than $50,000) with good credit, consider a debt consolidation loan
  • When you have bad credit or more than $50,000 to repay and you want to avoid further damage, a debt management program is usually the best option
  • If most of your debts are in collection, go for debt settlement

Student Loan Debt

  • If you have federal student loans from several different programs and want to make as many of them as possible eligible for federal relief, you’ll need to use a Federal Direct Consolidation Loan first.
  • Then if you need lower monthly payments, look for a hardship-based federal loan repayment plan.
  • For private loans, use private student debt consolidation; you can also use this for federal loans if you want to save money and aren’t worried about needing federal relief.
  • If you have other debts that take priority for repayment and you can’t afford to make you student loan payments, apply for deferment or forbearance.

Tax Debt

  • If excessive penalties and interest charges have driven up your balance, you need penalty abatement
  • If you owe multiple years of back taxes and need a payment plan that works for your budget, set up an Installment Agreement (IA)
  • When you have a tight budget and can’t afford to repay, file for Currently Not Collectible (CNC) status
  • If you owe more than you can reasonable afford to repay, go for tax debt settlement

Loans, including auto loans and mortgages

NOTE: Loans like mortgages or auto loans won’t be prioritized for repayment, but you might consider refinancing. That can help lower your payments and total costs over the life of these longer-term loans.

  • If you have unsecured personal loans, you may be able to consolidate them along with your credit card debt.
  • If you credit score is better than when you applied for your mortgage or car loan, consider refinancing.
  • Always make the payments on secured loans to avoid repossession and foreclosure; these are the last loans you pay off, but they’re the first bills you should pay every month.
  • If you’re facing extreme financial hardship and can’t may your mortgage payments, apply for forbearance.

Step 4: Implement your solutions and set up a budget

Once you start to identify solutions, you need to build a budget that focuses on meeting your new payment schedules.  If you don’t already have a budget in place, visit’s Create a Budget page.

As you find debt solutions and set them up, make sure to adjust your budget to include the new payments. Each solution you use should free up more cash flow, giving you more breathing room in your budget. Keep a close eye on how much cash flow you free up.

If possible, set up savings as a scheduled expense in your budget. Ideally, you want to save about 5-10% of what you take home each month. This will help you quickly build an emergency fund that you can use to cover unexpected expenses. That way, you can avoid taking on new credit card debt and can focus on repayment.

Savings should be treated as expense, rather than just using whatever money you have left over at the end of the month. You determine how much you can save, then treat that as a bill you pay yourself.

Once you have all your solutions in place plus savings, see how much free cash flow you have left. If possible, you may want to dedicate some of that cash flow to making larger payments or extra payments on the debts you need to pay off. This will accelerate your repayment schedule so you can get out of debt sooner. Just make sure to only put extra cash towards debts that have no early repayment penalty. In most cases, extra cash should be put to credit card debt repayment first.

Step 5: Set milestones that help you avoid financial hardship

Emergency savings protects your budget and money against more debtIt’s critical that while you pay off debt, you need to limit taking on new debt as much as possible. For instance, if you consolidate credit card debt with a debt consolidation loan, then immediately run up new balances, you just make a bad situation worse.

This means you need to set milestones and avoid taking on new debt until you reach them. There are two ratios that can help you determine if you’re in the right place to take on new debt:

  1. Credit utilization ratio
  2. Debt-to-income ratio

Credit utilization ratio: When you can start charging again

Credit utilization measures how much credit card debt you have relative to your total available credit limit. If the total limits on your credit cards is $10,000 and you owe $2,500, then your ratio is 25%. Anything above 30% is bad for your score and generally means that you’ve overcharged and need to cut back.

This can help you decide when your debts levels are low enough that it’s safe to start using credit cards. Once your ratio drops below 30%, you can consider making new charges. Until that point, you should put your credit cards on freeze.

Keep in mind that a lower utilization ratio is always better. So, you may decide that you want to keep your ratio at 10 or 15%. In that case, check your utilization ratio as you eliminate debt and only start charging once you reach the milestone you set.

Debt-to-income ratio: When you can start borrowing again

Debt-to-income ratio (DTI) measures how much total debt you have relative to your income. You basically divide your total monthly debt payments by your total monthly income. If you pay $1,000 per month and bring home $3,000, then your ratio is 33%.

In general, you want to maintain a ratio of 36% or lower. This will allow you to take on new debt without stressing your budget. Lenders check your ratio anytime you apply for a loan; they won’t approve you if the loan puts your ratio over 41%. So, you give yourself a 5% pad so you can take on new loans and get approved.

This means that you can use DTI to determine when you’ll be able to borrow again. Until your DTI is around 36%, you probably won’t get approved for new auto loans or personal loans. The one exception is a debt consolidation loan, since it pays off debt, which changes your ratio. If your ratio is around 41%, then you may be able to qualify for a consolidation loan.

Once your ratio is at or below 36%, then you can consider taking on other new loans.

Step 6: Keep an eye on your credit as you go

As you work to pay off debt, your credit score should gradually improve. On time payments will help you build positive credit history. That’s true as long as the lender authorizes the adjusted payment schedule. So, even if you use a debt management program or a federal student loan relief option, you build positive credit history. Since that’s the biggest factor used to calculate your credit score, your score should increase.

What’s more, each credit card debt you pay off also drops your credit utilization ratio. That’s the second biggest factor used to calculate credit scores. So, this should improve your score as well.

Of course, some debt solutions damage your credit. If you settle any debt, that creates a negative item on your credit report. It sticks around for seven years from the date of discharge. Settlements damage your score.

All of this means that you need to watch your credit closely as you pay off debt. You want to make sure:

  1. Account statuses are updated as you bring accounts current
  2. Your credit history shows all the payments as made on time
  3. Loans show as paid

If you simply want to wait until you finish your pay off plan, you can use free credit report downloads to review your credit once you’re done. If you want to track progress as you go, then you will need a credit monitoring service.’s Pay Off Debt FAQ

Does paying off debt increase your credit score?

In most cases, yes. Paying off debt builds a positive credit history and improves your credit utilization ratio. Since those are the two biggest factors used in credit score calculations, you should see your score improve.

Then why did my credit score drop after paying off debt?

There are three reasons why your credit score drops after paying off debt.

  1. You didn’t pay off the debt in-full (i.e. you settled)
  2. The repayment schedule that was approved by your creditors, meaning you didn’t make your payments as required.
  3. You closed credit card accounts after they were paid off

The only time settlement doesn’t negatively affect your credit score is with debt collections. In some cases when you settle with a collector, you can ask them to “re-age” your information to remove the collection account from your credit report. But unless you do this, settlement is always bad for your credit.

Payment schedules matter because they relate to your credit history. If the creditor did not agree to accept reduced payments and you pay less than the requirement, this affects your score. Always make sure creditors sign off on receiving lower payments that the requirements listed on your bill.

Finally, if you close old credit card accounts, you decrease your “credit age.” This is not a huge factor in scoring, but it counts. Whenever possible, try to keep your account open so you don’t decrease your credit age.

How fast does paying off debt increase credit score?

At most, you credit report should reflect changes within 30 days. Creditors report changes in accounts to the credit bureaus every 30 days – basically on a similar schedule as their billing cycle. So, if you pay off a balance, that should show up on your credit report within the next month. As soon as your credit report reflects the changes, your score will reflect them, too.

This is one of the reasons that credit monitoring can be useful. It lets you know exactly when the changes impact your score.

Do you have to pay debt collectors?

This really depends on personal preference and how old the debt is. As we mention above, old debts that are close to the statute of limitations should be given the lowest priority for repayment. And some people chose not to pay them at all and simply let the clock run out.

The issue is that collectors don’t always stop calling just because a debt is past the statute. They may still attempt to force payment. You can tell them to cease and desist if the debt is past its statute of limitations however, and they must honor that request. Since they can no longer sue you in civil court, that should be the last you hear about it.

If you don’t want that aggravation, then you may decide just to pay or at least settle with debt collectors to get them off your back. However, we recommend tackling all your other debts first before you decide what to do with old collection accounts.

Is it better to pay off debt or save?

We recommend doing both whenever possible. If you don’t save and focus all your extra funds on paying off debt, you end up generating more debt. Unexpected expenses always come up. And if you don’t have savings, they turn into credit card debt.

Following Step 4 above, your goal should be to find solutions that reduce your monthly debt payments. Then use some of the cash flow that you free up to build emergency savings.

Article last modified on January 16, 2019. Published by, LLC . Mobile users may also access the AMP Version: How to Pay Off Debt - AMP.