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How to pay off your debt: 5 steps to kick-start your debt repayment plan in 2024

5 min read

Pay off your Debt

Written By

Clay Shiffman

Rounding it up

  • If you have multiple types of debt, try consolidating them all so you end up with one loan, one monthly payment, and one interest rate.

  • If you’re denied a consolidation loan, call your creditors to negotiate a payment plan and speak to a non-for-profit credit counsellor.

  • If you’re unable to negotiate a repayment plan, it’s time to consider a consumer proposal or bankruptcy.

  • Don’t forget, even if it feels like you’re at a dead end with your finances, there is always more than one way out.

Debt can be a scary word. After all, poor debt management can lead to serious financial repercussions later. While you work hard to pay off any debt in your portfolio, it's not always easy to have a solid debt repayment plan that works for your situation.

With high inflation and interest rates, many Canadians are likely under a lot of financial pressure already to combat the rising cost of living. The average credit card debt in Canada is approximately $4,226 per person. The last thing you want to worry about is accumulating debt and struggling to pay off your loans.

An important part of having a sound financial portfolio is paying off debt and avoiding potential high interest payments. Regardless of market conditions, paying off debt quickly increases your cash flow for other purchases and your savings, ensuring you can reach your short- and long-term financial goals.

Unsure of how to tackle your debt responsibly to avoid getting into trouble with your finances? We share five steps to kick-start your debt repayment plan and help you become debt-free.

What is debt?

Debt is money you owe someone, such as an individual, lender, or other financial institution. When you borrow money from someone, you must repay them in the future, usually with interest on top of the principal. You can accumulate debt in many ways, such as spending money on a credit card, applying for a line of credit, getting a mortgage or car loan, or borrowing money for post-secondary education. The amount of debt you can have depends on your creditworthiness and how much the lender approves.

Is debt bad?

Debt can be good or bad, depending on how you deal with it. Having a good credit mix can help build your credit report. For example, making regular monthly payments on time for your credit card balances can increase your credit score and show lenders you're financially stable and responsible with your money. Taking out personal loans or other forms of credit can also help you make large purchases or get through an emergency when you're strapped for cash. Examples of good debt include auto loans, mortgages, student loans, credit cards, and small-business loans. You can productively use this credit to improve yourself or get out of a financially difficult situation.

However, you can also accumulate bad debt. Any debt that's difficult for you to repay or doesn't offer long-term benefits may be considered bad debt. If you're always late on your monthly payments, it could decrease your credit score, impacting your chances of getting loan approvals in the future or good interest rates and loan terms.

Why is it important to pay off your debt?

Debt can be expensive. Not only are you paying back the money you borrowed to the lender, but you'll probably have to pay interest, too. Regardless of your debt, paying it off on time prevents you from accumulating too much. Here's how a good debt payment plan can help you.

Build your wealth

Instead of putting money towards debt repayments and interest fees, you can put that money towards your savings and investments. Savings and investments are part of your assets, helping you achieve your financial and personal goals, such as paying for a vacation, post-secondary tuition, or buying your dream home. It also sets you up for long-term success when it's time to retire or when your financial responsibilities increase, such as when you have a family and kids. You get much more benefits from putting your extra money towards building your money than high interest rates.

Improve your credit score

Your credit score is essential in many decisions and helps you secure loans and low interest rates. Some employers and companies also review your credit score when considering you as a prospective tenant or employee. A low credit score can make it challenging for you to qualify for additional financing, and you may lose out on opportunities.

In addition to your credit and payment history, the amount of debt you have plays a big role in calculating your credit score. The amount of credit you use from your total available credit is your credit utilization. A high credit utilization can be a concern for lenders as it signifies potential financial struggles. Pay off debt quickly to lower your credit utilization ratio and increase your score.

Have better money management

Money management ensures healthy financial habits and puts you on the path toward financial success. If you struggle with monthly spending and paying bills, adding debt to your portfolio can complicate your life.

Juggling too much debt increases the risk of late or missed payments, which could result in defaults and more serious consequences. Having a regular debt repayment plan reduces some financial pressure so you can manage your debt more sustainably.

5 ways to pay off your debt

Becoming debt-free is probably one of your financial goals if you're drowning in debt repayments every month. Once you're no longer paying loans and high interest rates, you have more freedom to spend and save money to achieve any goals you have. While there's no "right" or "best" way to tackle your debt, here are some tips to help you get out of debt fast and improve your financial situation.

Make a list of your debts

Are you aware of your debt portfolio? Identifying your debts is the first step to paying them off. List the loans, credit cards, lines of credit, and other debts you have. Include the interest rates and total values of each debt to get a monetary value of how much you owe. You can also list how much money you pay regularly to lower your debt amounts, such as monthly, quarterly, or yearly replacements.

It is also a good idea to create a balance sheet of your financial situation. A balance sheet gives you a portrait of your personal finances, including assets and liabilities. You get a better overview of your situation and level of debt and whether you have the means to repay them. You can make better decisions once you have all the information you need and decide on the best course of action.

Restructure and negotiate your debts

Restructuring your debts means consolidating them to improve your overall financial situation. It reduces the interest you pay each month, lowering your financial stress and burden. Debt consolidation combines all your debts into a single loan with a more preferential interest rate, if possible.

Not only is it easier to deal with one debt instead of multiple debts, but the better interest rate makes it easier for you to keep up with monthly payments.

For example, let's say you have a credit card balance with a high-interest rate and a consolidated debt loan with a lower rate. You can pay off your credit card debt with a loan with a lower interest rate and monthly payment.

Figure out your baseline budget

A new loan can be beneficial sometimes, especially for large purchases like a house, education, or car. However, you should know how much debt you accumulate and can afford to spend. Creating a budget gives you an idea of your cash flow, which includes the money coming in and going out of your bank accounts. Taking on more debt than you can afford to repay can lead to late or missed payments, which impacts your credit score and future chances of applying for loans.

Take some time to list your different sources of income, such as full-time jobs, allowances, and part-time jobs. Next, list the expenses you have each month, including fixed and variable expenses. Fixed expenses, such as gym memberships, car insurance, mortgage, and student loans, stay the same each month.

Variable expenses change, such as groceries, gas, and dining out. Compare your income and expenses and decide whether you can afford to spend that much.

You can also list your short- and long-term financial goals, as you'll likely need to set aside money regularly to reach them. Consider how much money you need for each goal and how much you want to save each month. After factoring in your savings goals, think about how much discretionary income you have left for expenses.

Find a budget that you can reasonably sustain while meeting your debt repayment obligations and still leaving some room for the activities you enjoy. While you can't avoid some debts, you can reduce your leisure expenses and use the extra cash to pay your debts.

Do whatever you can to make the minimum payment

Credit cards usually have minimum payment requirements for each statement period. Making the minimum payment ensures you don't pay unnecessary interest expenses, which can add up over time.

Review your minimum payments with the lenders to determine the baseline for avoiding unnecessary debt expenses. The last thing you want is late fees or penalty APRs when you want to get rid of your debt as quickly as possible.

If you can pay your balance in full, it's important to do so. However, there may be times when that isn't possible, which is understandable and okay. Do your best to make the minimum payment to avoid falling into a debt cycle and pay off your balance as soon as possible.

Increase your income

A great way to tackle your debt is to increase your income. The more money you earn, the more you can afford to spend on repaying your debts. You'll also have less financial stress if you have more discretionary income. Here are a few ways to increase your income.

  • turn your hobby into a business

  • get a second job

  • increase your salary

  • sell items you no longer need

  • automate your savings

  • cut down on expenses

  • start a side business

It may take some trial and error to find the best way to increase your income, but even the smallest increase can make your life easier.

Decide which debt repayment plan you want to follow

Once you understand how to reduce your debts over time, you can create a strategy that you can realistically sustain and take action. Here are two simple methods to consider.

Pay debts with the highest interest rates

Any loan you have likely has an interest rate attached. The interest rate is the cost of borrowing money, and lenders require you to pay the principal and interest owed. The higher the interest rate, the more expensive it is to borrow money and the more you'll pay with each repayment. When you pay off high-interest debt first, you pay less overall interest, saving you money and helping you be debt-free sooner.

List your debts and their associated interest rates in descending order. For example, payday loans typically have one of the highest interest rates, followed by credit card balances and personal loans. Student loans generally have a lower interest rate in comparison.

Once you make the minimum payments on your debts, use the leftover money to tackle loans with high interest. This method is also called the avalanche method because you pay off debt with the highest interest rate and work your way down to the lowest rate.

Focus on small balances

Sometimes, taking the first step is all the motivation you need to kick-start your debt repayment journey. Instead of trying to tackle everything at once, it may be helpful to start with your debt with the smallest balance. Create a solid plan for getting rid of your lowest balance, and you'll feel much more accomplished and motivated to continue to repay your debts.

For example, you can focus on eliminating credit card debt first, as it's relatively easy to deal with compared to bigger loans. However, beware of debts with high interest rates, as it may cost you more over time to focus on the smallest balances first. This method is also called the snowball method.

How to manage debt during a recession

If you're struggling with debt, you can always reach out to your creditors and financial institutions. You can speak with a financial advisor to help you reorganize your finances, or see if you can negotiate your debts. Credit companies and financial institutions may be willing to provide better terms to ensure you repay the money you owe. For example, they may extend the payment deadline or reduce your monthly payments so you can avoid penalty fees.

What is credit repair vs. debt consolidation?

Credit repair vs. debt consolidation are two important concepts to understand. Credit repair means fixing mistakes and discrepancies on your credit report. It can improve your credit score, helping you negotiate better terms for your loans and making your monthly payments cheaper. Debt consolidation is when you ask the creditor or financial institution to pay off your debt for less than the amount owed. Look at your financial picture and work with a professional if needed to leverage tools for credit repair and debt consolidation based on your situation.

Should you continue to save while paying off your debt?

Working towards your saving and investment goals is just as important as paying off your debts. In an ideal world, you can prioritize both at the same time. However, that's probably not feasible for most Canadians. Manage your debt first before you put money into savings. Borrowing money can be expensive, and you want to avoid interest or penalty fees as much as possible. Use your budget and debt repayment plan to focus on lowering your current debts. Once you're confident you can save money without incurring future debt and penalties, you can create a savings plan.

Consider a secured credit card

If you struggle with paying credit card debt, a secured credit card may help you manage your credit card bills better. A secured credit card is backed by a cash deposit equal to your credit limit. The cash deposit acts as collateral whenever you make purchases with your card. Secured credit cards can help you get back onto your feet, create healthy financial habits, and handle debt responsibly. These cards typically have more lenient approval requirements, making them great for high-risk borrowers and people looking to build or repair their credit history.

Manage your debt and finances with KOHO

We understand it can be stressful to manage your debt and finances. When you have savings and investment goals, you want nothing more than to get out of debt faster. That's where we come in. KOHO offers many products to help pay off your loans and build healthier financial habits.

The virtual credit card gives you access to your available credit from your phone, allowing you to make purchases and earn cash-back rewards to save a few bucks. Worried about going over your limit? Subscribe to Cover overdraft protection coverage to get up to $250 zero-interest cash advance for unexpected expenses that push you over your available credit. You won't rack up additional debt as long as you pay your subscription fee and repay the full amount on time.

Part of getting out of debt is rebuilding your credit score to ensure you can secure lower interest rates and good loan terms in the future. Monitor your credit report with a free credit score and get valuable insights into what you're doing well and how to improve.

Whether you're looking to make everyday purchases conveniently with a credit card, earn interest and save for the future, or build your credit with KOHO, we've got you covered.

Note: KOHO product information and/or features may have been updated since this blog post was published. Please refer to our KOHO Plans page for our most up to date account information!
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