Cracking the Debt Free Code

Debt is a burden that affects almost everyone nowadays, especially credit card debt. According to LendingTree, Americans are holding $986 billion in debt collectively, with the average cardholder carrying a balance of $7,279 in December 2022.

That’s a lot of debt! Especially with credit cards, which are notorious for having extremely high-interest rates, which eat away at your ability to get ahead financially. After making a few not-so-great choices in my early 20s, my wife and I focused our efforts on getting out of debt (except for our mortgage).

Getting out of debt does wonders not only for you financially but mentally and emotionally as well. Once our final payment was made, we felt such relief knowing that we were free.

We hold onto this feeling as we continue to pursue financial independence. Below are the steps we took that worked well for us, along with how to stay out of credit card debt. 

Good debt vs. bad debt

All debt can be considered bad as compound interest works against your ability to generate wealth; there are a few types of debt that are considered better than others. One example is a mortgage. You need to live somewhere, right?

At least with a mortgage, there’s a chance that the home value will appreciate. There are two key distinctions between good and bad debt.

Good debt can enhance our financial situation in the long term. Good debt carries lower interest rates, typically 7% and below. One of the worst debts is credit cards, which currently have an average interest rate of around 24%. 

Another example of good debt is a student loan – if you need to take on a little bit of debt to pursue a more lucrative career, it’s not a bad idea. Just make sure that there is a good return on investment.

For example, if you take on $30,000 in student loans to pursue a career that will increase your salary from $25,000 to $35,000, you may not be able to pay off your loans anytime soon and will be stuck paying interest for many years.

But if you take on that debt to increase your salary from $25,000 to $80,000, it may be worth it. Just make sure to put your extra earnings into getting out of debt. 

Create a budget

The first step in paying off your credit cards and other debt is to create a budget. A solid budget will help you identify your spending habits and areas you can reduce.

Once you’ve identified cost savings, you can reroute these savings to paying off your debt. Consistency is key – when creating a budget, be realistic about what you can cut for the long term. Remember, the goal is to get out of debt.

Depending on how much debt you’re carrying, it may take some time. You don’t want to burn out before the debt is paid back in full. 

If you don’t currently have a budget, there are many strategies to choose from. I highly recommend starting with the 50/30/20 budget; it is very easy to set up and follow.

Each month, you dedicate 50% to needs, 30% to wants, and 20% to investing and debt management. This is just a starting point, the more you can put towards investing and debt management, the faster you’ll get out of debt and invest for the future.

If you’re a single-person household and/or a single parent, check out this great article that SB recently published that goes over some additional tips.  

Debt consolidation options

If you have several sources of high-interest debt, I would consider a debt consolidation product. Not only do these products help you roll several debt sources into one easy-to-manage payment, but they can also help reduce any anxiety you may be feeling by having several bills coming in at once.

The trick is to find a product that has a lower interest rate than what you are paying today. Personal loans typically carry an interest rate of 8.5-11%, but it will depend on your financial situation. This is a great way to drastically reduce your credit card interest burden.

If you’re carrying credit card debt month-to-month at a high-interest rate – let’s say the average of 24% – you can get a personal loan at 11% and cut your interest burden by more than half. That’s a huge savings each month. 

If you have a small amount of debt you plan to pay off in 12-18 months, I will look into a balance transfer credit card. Balance transfer credit cards offer 0% interest for the first 12-18 months before jumping up to mid-twenties. Review the terms carefully, as some card issuers have limits on how much you can transfer over.

For homeowners, there are a few ways to use your home equity to get out of debt. You can pursue a home equity line of credit (aka HELOC), a home equity loan, or consider a cash-out refinance.

HELOCs and home equity loans typically offer lower interest rates versus credit cards which are a great way to reduce your interest burden. A cash-out refinance pulls the home equity from your home and gives it to you in cash, which you can use to pay off your debts.

One word of caution is that when you do this, you have to pay closing costs again, and you are essentially restarting your mortgage, potentially at a higher interest rate and monthly payment. Take some time to explore your options before making a decision, and consider your full financial situation.

We were fortunate when we refinanced our home; the interest savings made up for the closing costs after 18 months. Every day after that point was savings on our mortgage, which has been well worth it.

Staying debt free

My wife and I stuck with our debt repayment budget, even after paying off all of our bad debt. Since the debt was paid off, we put in the extra money to create an emergency fund to cover us if something unexpected happened. We then started to invest for our future retirement, and now we put money away for our daughter’s future. 

Regardless of where you are on your journey, remember that you’re not alone. There will be others ahead of you, behind you, or at the same stage. I’d encourage you to find a buddy or two to help keep you motivated and stay on track.

Being mindful of your spending and consistently following your budget will lead to paying off your debt and achieving your financial dreams.

Jeremy’s Bio 

Jeremy is a FinTech marketer by day and a blogger by night. His blog, Knocked-up Money, focuses on helping parents and parents-to-be get a handle on their finances to pursue financial freedom and create generational wealth. As a parent with limited income, he practices what he preaches daily in the fight against inflation and ever-rising costs.