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How to Pay Off Debt When Cash Is Tight

Updated: Nov 28, 2022

Follow these guidelines to pay off your loans, bills, and debt—even, or especially—when you're on a tight budget

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Debt may be a four-letter word, but it's also a part of most of our lives. In fact, did you know that 60 percent of college graduates have some sort of debt, equaling a total of $1.41 trillion in total outstanding student loan debt? And that's just student loan debt. We're not including mortgage, auto, and credit card debt.

So, okay, most of us have some kind of debt. And it's okay! While it's totally fine to have debt, you'll want to make a plan to pay it off, while considering your plan for the future—i.e., your retirement savings like your 401(k), 403(b), Roth or Traditional IRA; and your rainy day fund for when life gives you unexpected emergencies.

Your action plan

Determine your net worth snapshot.

Alright, first thing's first. Your first step is to determine how much money you have, what's coming in, what you owe, and how much you have left over to throw into savings (or entertainment). This data dump is called your net worth snapshot. And, once you have this in place, you'll be able to start making more decisions.

Update your budget.

Don't have a budget? No problem! Now's the best time to start one. Especially if you're dealing with some unforeseen expenses. (Psst, Gallup found that only one in three people keep a detailed budget, so you're not alone!) Just like everyone has their own favorite flavor of ice cream, everyone has their own version of a budget that works for them. For example, some people like to have a super detailed budget that tracks every penny; others prefer a budget that paints a bigger picture and tracks the main tenants of their monthly cash flow. The main idea is to just find what works for you and stick to it.

Consider how much you should be allocating to spending, saving and debt payoff.  An industry rule of thumb is the 50/30/20. That means you're putting 50 percent of your income to your to needs (home, car, food), 30 percent to wants (Netflix—sorry!), and 20 percent to savings and debt payoff.  If you're like many of us and want to strive for that little extra, swap the 30 and 20, and put 30 percent of your income to savings and debt payoff, and 20 percent to your wants. The choice is yours!

Depending on your situation, refinancing could be your best bet. Many refinance their mortgages or student loans to lower their interest rate, consolidate debt, or shorten the mortgage or loan term—in other words, put extra money in their pockets! Cha-Ching! 🤑 But, before you get too excited, know that are things to consider before diving into a mortgage refi or student loan refi head-first. For one, just because you're lowering your monthly payment, doesn't mean you're paying less! In fact, you could be paying more in interest, as you're extending your loan term. Another thing to keep in mind, as it relates to your student loans, is that you don't have to refinance the whole thing; you can refinance parts of your loan. (Plus, keep in mind you may qualify for the student loan payment pause. Check in with the U.S. Department of Education for more up-to-date information.)

Don't forget about the future

Ideally, you're saving for the future each month, even when paying off debt. Sometimes you may wonder, Do I pay off my student loans or save for my retirement? The answer is both! If you can swing it, try to pay toward your debt and your future. For example, if you find yourself with $500 of extra cash each month, put $250 toward your debt and the other half toward your retirement and/or emergency cash fund.

Your emergency cash fund is set aside for unforeseen expenses that you'd otherwise put on your credit card, and therefore, only add to your debt. It's good to have three to 6 months' worth of expenses saved up in this fund, to keep you on your feet in the event of an emergency.

As for putting money into your retirement fund, you'll want to make sure that the interest rates make sense! Keep in mind that putting money into your retirement account will mean that you're paying off your loan principal more slowly, and therefore paying more in interest. If your savings interest is higher, then it's okay! That means that you're earning more money on what you're putting into your savings account than what you're paying in interest for having a longer loan term.

Keep in mind that, while that logic may be true for some loans, it's likely not true for credit cart interest rates. Credit cards rates tend to be higher than savings interest rates. That means, over the long-run, you'll end up spending more money on debt interest than what you're earning in your savings interest.

Remember: the main goal is to pay down your debt and save for the future. Some months, you might have to pay more toward debt than your retirement accounts. And that's okay! Just be sure to keep your future top of mind, so it's not something that you have to scramble to build at the last minute. And, in that case, you'll have to pay way more each month to reach your retirement savings goal. (Trust us; you'll save WAY more if you start saving younger.)

Paying off debt isn't the simplest feat. But, we're here to help you navigate your way through it and find financial wellness.

Download Pocketnest and get your finances in order—in just 10 minutes a month! No jargony finance-speak, pricey fees or in-person meetings required.

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