Debt Management

How to Budget for Debt Payoff

Having a budget can help you reach your debt repayment goals faster and more consistently by giving you a structure that you can use to allocate your money as needed.

With a comprehensive budget, you have a solid grasp of how much money you’re making each month, how much you’re spending, and where you’re spending it. It also helps you determine how much money you can set aside to pay off debt and how much money you can apply to savings (such as emergency funds) and investments (such as retirement accounts).

It also tells you how much extra you have in the budget to spend on “non-essential” expenses like vacations or entertainment.

In this article, we’ll cover getting a solid understanding of your debt, budgeting for your debt payments, and effective debt repayment strategies so you can live debt-free and worry-free.

Understanding your debt

A loan can be classified as secured or unsecured.

  • Secured loan. It refers to any form of loan that is backed by some form of collateral. For example, the collateral on an auto loan would be the vehicle while the collateral on a mortgage would be the house.
  • Unsecured debt. This is a loan that is not backed by any collateral. Credit cards are an example of unsecured debt. Interest rates on unsecured loans are often higher because there is no collateral to cover the borrower’s risk.

So, what type of loans should you prefer? Here are some examples of debt to help you determine which debts to pay off first:

Payday Loans

credit card

Auto loan

mortgage

APR interest rate

About 442%

Typically 19.99% to 25.99%

About 8.24 percent by January 2024

Varies with conditions. Between 5.52% and 8.73% in 2023

Collateral risk

no Straight danger

no Straight danger

Danger to the vehicle

Home risk

Non-payment penalty

Penalty fees (most vary by province)

Interest charges on outstanding balances

Collection actions

Unpaid debt lawsuit

Possible increase in late fees and interest rates

Collection actions

Unpaid debt lawsuit

Report non-payment to credit bureaus

Late payment fee

Possible repossession of the vehicle if delayed by several months.

Report non-payment to credit bureaus

Late payment fee

Possible foreclosure or other legal proceedings on the home such as a Sales force

Report non-payment to credit bureaus

Which of these debts should you pay off first? If your goal is to reduce the amount spent on interest charges, payday loans should be paid off first. Next would be credit card debt. Meanwhile, for auto loans and mortgages, enough money should be set aside to cover your minimum monthly payments.

However, if your financial priorities are to qualify for another loan (such as a consolidation loan), raise your credit score, or use less credit, you may want to prioritize paying off other loans first, because payday loans Not reported to credit bureaus.

How to Budget for Debt Payoff

When setting up a budget for paying off your debt, it’s important to start with an analysis of your income and expenses. Here, free tools like Credit Canada’s Budget Planner can be helpful.

A traditional method of budgeting is to follow the “50/30/20” rule. This means that the amount you earn:

  • 50% will go towards “necessities” such as living expenses, food, your car, etc.
  • 30% will go towards “wants” like entertainment, travel, subscriptions, etc.
  • 20% will go towards savings and debt repayment.

How do you determine how to categorize needs vs. wants?

“It’s very easy to confuse a need and a want, especially if it’s something we really want. So, it’s easy to keep in mind the difference between needs and wants. Do I need it to survive?“~Jordan Kaye, Personal Finance Writer

It’s important to find the right balance between paying off your debts and saving for the future (or even for your personal financial goals).

In addition to the 50/30/20 rule, there are other budgeting systems, such as “zero-based budgeting,” which looks to use every dollar you earn in some form—even if it’s in the form of contributing to debt. be me Payments, savings accounts, or investments.

Similar to the envelope system is the “mini-bucket system,” where you set up different bank accounts or envelopes for different types of expenses to strictly limit your spending for each type of expense.

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When setting up your loan repayment plan, try to set a goal that follows the SMART framework (ie, a goal that is specific, measurable, attainable, relevant and timely). An example would be “Pay off my student loans in the next ten years.” This helps you stick to your payment plan for the long term.

Effective debt repayment strategies

Once you know what your income and minimum monthly expenses are and how well they align with the 50/30/20 rule, it’s time to choose a debt repayment strategy. There are two different payment strategies to choose from:

  • The snowball method. Pay as much as you can for your small loan, regardless of the interest rate, while maintaining the minimum payments on your other loans.
  • The avalanche method. Put as much money as possible into your highest-interest debt first while maintaining minimum payments on other debts.

These methods have various advantages. For example, the avalanche method saves you more money in the long run, while many people find the snowball method easier to motivate because you focus on the smallest first. So the loans disappear quickly.

Tips to Enhance Your Debt Repayment Strategy

To help improve your debt repayment strategy, consider these tips:

  • Reducing costs. To help free up space in your budget to clear your debts faster, identify unnecessary expenses and cut them as much as possible. Reducing expenses allows you to devote more time to paying off your debt so your debt is paid off faster.
  • Using “side hustles” to raise your funds. Make more money by participating in the gig economy (companies like Uber, Turo, Skip the Dishes), reselling old collectibles online, or making items to sell yourself on platforms like Etsy. Just make sure to submit your taxes with your side hustle!
  • Using the windfall to clear the debts first. When you get a lump sum (such as from an inheritance or lottery winnings), it’s often better to use that money to pay off your credit cards or other high-interest debt than to save or spend it.
  • Take advantage of debt consolidation. Debt consolidation is when you take out multiple loans and consolidate them into one payment. This may include debt consolidation loans, debt consolidation programs/plans (DCPs), or rolling the debt into your mortgage.

“We don’t see debt management as an area of ​​savings. However, the best way to save is to eliminate debt. -Mike Bergeron, Credit Counselor, Credit Canada

Maintaining your budget and debt plan

Once you’ve decided on a debt repayment strategy (or combination of strategies), it’s important to stick to your debt repayment plan. Some quick tips for sticking to your budget include:

  • Get help. Maintaining a budget can be difficult. But you don’t have to do it alone. Seeking help, either from friends and family members or from professionals such as accountants, financial advisors, or nonprofit credit counselors, can help motivate you and improve your financial management to get out (and stay) out of debt. Finding ways can help.
  • Review your credit status from time to time. Track each of your debts and review them at least once a year so you can address changes in your debt situation and adjust priorities as needed to keep your repayment plan on track. can do
  • Use a budgeting app. There are apps you can download to your smartphone or other mobile devices that help you track your spending habits, alert you when you go over budget, or find opportunities to cut back on your spending. can help. Many financial institutions have their own dedicated app for this.
  • Set up payment reminders. Make reminders about your payment due dates on your calendar to avoid paying off your loans.
  • Use automatic payments if available. To make consistent payments easier, consider setting up automatic payments to creditors.
  • Consolidate your debts. The fewer debts you have, the easier it will be to keep track of them and pay them off. Debt consolidation helps reduce the total number of payment deadlines you have to keep track of.

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