Morgan Stanley
  • Wealth Management
  • May 2, 2022

How to Create a Debt Payoff Plan

When debt payments become overwhelming, devising a payoff plan can put you on a path toward financial freedom.

If you’re working to eliminate debt, you’re not alone. The average American now carries more than $90,000 in debt, including from credit cards, student loans and mortgages.1

Not all debt is a bad thing; mortgages and student loans, for example, help you invest in yourself and your future. But endless payments and ever-mounting interest could make it harder for you to meet other goals, such as saving for retirement or investing in the markets.

The following steps can help you create a plan to pay off your debt and take control of your finances. 

Document Your Debt

Create a spreadsheet that lists all of your loans and credit cards, their balances, monthly payments and interest rates. Include both unsecured debt (which is not backed by property, like credit card or medical debt) and secured debt (which is backed by property, such as a mortgage or car loan).

Getting a clear picture of exactly how much you owe, and might owe in the future because of interest, is the first step in getting your arms around your debt.

Decide Which Debt to Pay Off First

There are two popular methods for repaying debt: the snowball method and the avalanche method. Each has a different philosophy about which debt to pay off first.

Debt snowball: Under this method, you make minimum payments on all your debts and then devote extra funds to paying off balances from smallest to largest. The idea behind this strategy is that early success paying off small balances gives you momentum and motivation to tackle the larger ones. The drawback is that you are not necessarily prioritizing high-interest debt, and interest charges incurred on that debt could be costly.

Debt avalanche: With this approach, you eliminate debt according to interest rate, from highest to lowest. In essence, you’re prioritizing the debt that is costing you the most, regardless of balance. The drawback here is that it might be harder to stay motivated if your most expensive debt has a high balance, since it could take longer for you to see the results of your effort.

Is one method better than the other? That’s subjective, and it depends on your goals. If your priority is interest savings, the debt avalanche could be a better choice. For those who like the momentum that can come from accomplishing smaller tasks, the debt snowball could be the preferable option.

You could also get the best of both worlds by combining both strategies; for example, pay off your highest-interest debt first for savings, and then move on to the lowest balance to keep the momentum going. 

Consider Restructuring Your Debt

If having to keep track of multiple monthly payments becomes unmanageable, or high-interest charges are making it difficult to pay off your balances, debt consolidation or refinancing may be worth exploring.

Consolidation refers to borrowing a lump sum to pay off your debt, thus combining many balances into one. Refinancing is using a new loan or line of credit to pay off existing debt while changing the contract terms in some way, such as lowering the interest rate.2

These methods have their advantages but be aware that applying for debt consolidation or refinancing could trigger a hard inquiry on your credit report, resulting in the loss of some credit score points. That said, the impact on credit scores varies. Someone with a limited credit history could see a larger impact from a hard inquiry than someone with a long credit history.3 Depending on your goals, the temporary credit score drop may be worth the convenience or savings that comes from debt consolidation or refinancing. 

Automate Your Payments

After you’ve documented, prioritized and structured your debt, consider setting up automated payments. With debt payments happening automatically, you won’t have to remember to make each one, and you can rest assured they’re being made on time.

The benefits of this are twofold: making consistent payments will lower your balances, and on-time payments can help you build a positive credit history. Of course, you’ll need to be sure you’re keeping sufficient funds in your account to avoid overdraft issues.  

The Bottom Line

Developing a plan for your debt puts you in better control of your balances. List out your debts to see where you stand, prioritize your repayment targets and consider restructuring to make things easier to manage.

Lastly, if paying off debt becomes a burden, don’t be afraid to ask for help. There are many debt counseling services available, and financial professionals can talk through the available strategies for reducing—and eventually eliminating—your balances.