3 Tips To Consider Before Paying Off Debt

Tackling any amount of debt is a significant part of financial planning. Here are three things you should consider before building your repayment strategy.

3 Tips To Consider Before Paying Off Debt

There are so many different opinions about debt. Some see debt as a barrier to financial success, and others see debt as the holy grail of financial prosperity.

But not all debt is created equal, nor does it affect everyone in the same way: Black Americans are negatively impacted more by debt, particularly student loan debt, than their white peers. For example, according to Business Insider, “an average black graduate has $7,400 more in student debt than his or her white peer,” and “white borrowers pay down their education debt at a rate of 10% a year, compared with 4% for black borrowers.”

Knowing this and the overall issue of debt in the United States compared to other countries, it’s imperative that Americans, particularly Black Americans, create a plan to tackle this head-on. Ultimately, how you tackle debt should be a personal choice based on your financial goals.

For example, if you’re someone who wants to eliminate debt as quickly as possible, then creating a payment plan around that goal may be your priority. If, on the other hand, your goal is to maintain your current lifestyle, then the focus may be managing debt versus eliminating debt.

Here are three things you should consider before you start paying off your debt:

1. Take note of your spending and create a plan.

A spending plan that accounts for all your required expenses gives you an idea of how much extra money you have to put towards your debt.

Money is finite, so to pay off debt, you will have to prioritize how you spend your money.  If your budget is tight, think about how to spend money only on the things you care about, rather than the things you don’t. Cut costs on the objects and experiences that don’t bring added value to your life.

2. Build your emergency savings.

The second thing you should consider is beefing up your emergency savings to at least 3 months of expenses. This is particularly true now, during a worldwide pandemic, when many Americans have lost their jobs and are struggling to find new opportunities in a crowded and competitive job market.

The New York Times also states that “African-Americans also earn less, are quicker to be laid off, are slower to be rehired and are less likely to be promoted. Historically, the black unemployment rate is twice that of whites.”

Saving even three months of expenses may sound like a lot, but without an emergency savings account, you may be one unexpected expense away from getting into more debt.

When comparing accounts for your emergency savings, consider ones that allow you to move your money as often as you would need and that offer interest to counteract the effects of inflation.

One efficient way to save is by using Betterment’s Cash Reserve account, a high-yield cash account that has unlimited transfers in and out, no fees or transfer amount limits, and FDIC insurance up to $1 million for individual accounts (or $2 million for joint accounts, should you wish to save with a partner)†, once deposited at our program banks.

For Cash Reserve (“CR”), Betterment LLC only receives compensation from our program banks; Betterment LLC and Betterment Securities do not charge fees on your CR balance.

3. Choose your debt payoff strategy.

The third step to paying off your debt is to choose a long-term debt payoff strategy that will inspire you to stay-the-course.

However, in the short-term, always ensure that you are making on time, minimum payments to your loans, since it will save you from being charged extra penalties and fees and from negatively affecting your credit score.

Here are four ideas to help inspire you:

  1. Debt avalanche: Pay off debt with the highest interest rate first. Depending on your personal situation, this is often the most recommended strategy since it allows you to save money you would have spent paying off interest. What’s considered a high interest rate can vary, but typically it’s an interest rate higher than 5%.
  2. Life-altering debt: Pay off debt that, if unpaid, can be damaging— things like tax penalties, certain loans, liens, and judgments due to court decisions.
  3. Debt snowball: Pay the smallest balance first. This is best if you’re motivated by quick wins.
  4. Debt that triggers an emotional reaction: Pay off debt that makes you feel negatively every time you see the bill. This is an option for those with financial obligations tied to emotionally charged events, like divorce or the death of a loved one.

It’s important to note that in whatever strategy you choose, rarely is high-interest debt a good thing. Prioritizing debt with the highest interest rate will generally save you more money and allow you to redirect funds to other financial goals faster.

Ultimately, paying off debt requires planning, discipline, and most importantly, patience. Life will still happen while paying off debt. There will be seasons where you may have to pause your accelerated payments and seasons where you can afford to pay more.

The key to all of this is to stay the course, and hopefully you’ll reap the rewards in the future.