Otterwize

What You Otter Know About Personal Finance

Paying Off Debt

Whether it’s consumer or student debt, here are some ways to help eliminate it.

Consumer Debt

Here’s a bad 4-letter word: debt. Your goal should be to get out of consumer debt as soon as possible and to try (VERY HARD) not to run up more debt. The credit-card companies and other consumer lenders make tons of money off your debt, thanks to the compounding of interest (sometimes at ridiculously high rates). Don’t be so nice to them. Line your pockets instead of theirs by paying off your debt and staying debt-free.

Get organized

  • Gather the most current statements that you have on any consumer debt (credit-card debt, car loans, other personal or consumer loans, in-store financing, etc.)
    • Student loans should be addressed separately, because federal student loans have unique issues to consider, such as loss of federal benefits if you consolidate or refinance. For this reason, we cover paying off student debt in a separate tab on this page.
  • Make a list of all your consumer debt. Include outstanding balance due, creditor, interest rate, minimum monthly payment, and type of loan (credit card, auto, consumer loan, in-store financing, etc.).

Rank the debt by interest rate from highest to lowest and pay off the highest-interest debt first

  • Rank the debt in order from highest interest rate to lowest interest rate.
  • Start to pay off the highest-interest debt first (while still meeting the minimum payments for the other ones).
    • Some people prefer to rank the debt from highest balance to lowest balance and pay off the lowest balance first so they can see progress. If you really need that adrenaline boost, then OK, but you’ll save more money if you knock out the highest-interest debt first, then the next-highest, on down the line.

Ask for a lower rate

  • Call your credit-card company to see if you can negotiate a lower rate.
    • Sometimes a simple phone call (or email or online chat) is all it takes to get them to lower your interest rate.
  • Mention your strong on-time payment history, if you have one (and hopefully you do have one).

Consider a balance transfer

  • If you have a small amount of credit-card debt (no set rule here, but something around $5,000 or less, depending on your financial situation) on multiple cards, consider a balance transfer to a lower rate card (or a 0% interest offer for an introductory period).
    • Sometimes your credit-card company or other companies competing for your business will offer you balance transfer perks such as reduced rates or 0% interest on any balance transfers for a set period of time.
    • Make sure you find out how long this reduced rate is good for (sometimes called the “teaser rate” because it gets you in the door but doesn’t last forever) and, more importantly, what the rate will be increased to after the introductory period is over.
    • Make sure you understand that there is often a balance transfer fee (usually around 2%), so do the math (to decide if the amount of the fee is financially worth the reduction in interest).
  • If you think it’s likely that you’ll be able to pay off the balance before the introductory period is over (i.e., you have some kind of deferred income, seasonal or cyclical income or bonus, etc.), it may make sense for you to consider this option. If it’s unlikely that you’ll be able to pay off the balance before the introductory period is over (and the rate is going to shoot back up), it probably would not make sense to consider a balance transfer (unless the regular rate after the intro period expires is a lot less than you were paying on your other card).
  • If the offer is not from your own credit-card company but involves taking out a new credit card, keep in mind the possible effect this may have on your credit score.

Consider consolidating or refinancing

  • Consider consolidating or refinancing your debt at lower rates.
    • Consolidation means combining multiple loans into one loan at a lower rate.
    • Refinancing means going through the financing process again with the goal of getting a lower rate on your debt.
  • There are many online lenders that offer consolidation and refinancing options.

Pay down the loan balances by saving more and/or earning more

  • Save more (see “Before you break the piggy” and “Saving Apps” for ways to save money) and use your extra savings to pay down your principal balance even faster.
  • You might also want to automate payments every month to your credit-card company, in addition to whatever monthly minimum you also pay. (Just make sure the cash is in your account to avoid overdraft fees.) This extra boost every month will make a difference in the end.
  • Chip away at the debt any way you can:
    • Look at your budget to try to find ways to free up extra money that can be put towards your debt balance.
    • Take on a side hustle to bring in additional income.
    • If you are due (or overdue) for a raise or promotion at work, consider making a good case for yourself, being proactive, and seeing what you can get if you just ask.
    • If you receive a year-end bonus, commissions, tax refund, or some other one-time sum, resist the temptation to spend it. Put it toward reducing your debt balance instead.
    • Cut back on things like eating out, subscription plans, or other areas where you might overspend.
    • Try a staycation instead of spending money on a vacation with flight and hotel.
    • See if there are any items in your home that you don’t really need and that could be sold to generate additional funds. (See, e.g., Decluttr, Ebay, and CraigsList.)
    • Think about ways to reduce your housing costs for a while (getting a roommate, if you don’t already have one, moving to a less expensive place when your lease is up, or moving back home, if that is an option).

When you have made the last payment . . .

  • When you have finally paid off your credit-card debt, this is a time to celebrate your new-found freedom from debt.
  • Resist the temptation to slip back into the spending mindset that got you into debt in the first place.
  • Other than absolute necessities (like unexpected medical bills, e.g.), make a point of only putting things on your credit card that you know you will be able to pay for at the end of the month.
  • Pay your credit-card bill on time and in full every month going forward.

Student Debt

A student loan is an investment in your future because, to some degree (pun intended), your future earnings and earnings potential are affected by your educational level. But a pile of student debt is not a very welcome graduation present. There are a few ways to help reduce the burden: look into consolidation and refinancing options; see if your loan is eligible for forgiveness or cancellation (wouldn’t that be amazing?); or find ways to save more money and pay off those loans sooner.

Direct consolidation loan vs. private refinancing

Direct Consolidation Loan

  • A Direct Consolidation Loan is a federal student loan consolidation program administered by the U.S. Department of Education.
  • Direct Consolidation Loans allow you to consolidate multiple federal student loans into one federal loan.
  • There is no application fee to consolidate.
  • Direct Consolidation Loans are only available for federal student loans, not private student loans.
  • The interest rate on a Direct Consolidation Loan is not a reduced rate. It is a fixed rate calculated as the weighted average of the interest rates on the consolidated loans, rounded up to the nearest one-eighth of one percent.
  • Direct Consolidation Loans have several repayment options—including income-driven repayment plans—and Standard Repayment Plan terms from 10 to 30 years, depending on the amount of total education loan debt.
  • Before you consolidate your federal student loans, be aware that consolidation may cause you to lose certain federal benefits, such as interest-rate discounts, principal rebates, and some loan cancellation benefits. Also, if you are currently paying under an income-driven repayment plan or if you have made qualifying payments towards Public Service Loan Forgiveness, you will lose credit for payments made towards those plans if you consolidate your current loans. Make sure you weigh the pros and cons before you consolidate.

Private Refinancing

  • Private refinancing allows you to consolidate and refinance federal or private student loans. (Some private lenders will only refinance private loans.)
  • Private refinancing is available from private lenders such as banks, credit unions, and online lenders. 
  • The interest rate on a refinanced loan is (hopefully) less that the rates on the original loans (otherwise it would usually not have been worthwhile refinancing—unless you just wanted to lower your payments with a longer term).
  • Private refinancing of federal loans means loss of federal student loan benefits such as loan forbearance or deferment, public service loan forgiveness, income-driven repayment plans, and other benefits. Before you refinance your federal student loans privately, it is important to determine whether you are or will be eligible for any federal benefits that you won’t want to give up by refinancing privately. 

The pros and cons of direct consolidation loans

  • Pros:
    • One monthly payment instead of many (consolidating many loans into one means you just have one payment to keep track of)
    • Can lower monthly payment with longer loan term (up to 30 years)
    • Variable-rate loans can become fixed
    • Consolidation of loans other than Direct Loans may give you additional options for income-driven repayment or Public Service Loan Forgiveness.
  • Cons:
    • Higher total interest over the life of the loan if you select longer loan term
    • Loss of certain borrower benefits such as interest-rate discounts, principal rebates and some loan cancellation benefits. Read all the fine print carefully before you consolidate so that you don’t give up certain valuable benefits.
    • If your current payments fall under an income-driven repayment plan or constitute qualifying payments towards Public Service Loan Forgiveness, consolidation will cause you to lose credit for payments towards those plans. Before you consolidate, make sure you understand what benefits you may be giving up.
    • Rounding up to the nearest one-eighth of one percent can cause a slight uptick in interest rate which can have a noticeable impact on larger amounts of debt over time.

The pros and cons of private refinancing

  • Pros:
    • Lower interest rates may be available especially if your credit score has improved since you applied for the original loan
    • Lower monthly payments (due to lower rate or longer term)
    • One monthly payment instead of many (consolidating many loans into one means you just have one payment to keep track of)
    • More financial independence (through the possibility of releasing a parent or other co-signor from an original loan)
  • Cons:

Loan forgiveness or cancellation

  • Certain types of federal student loans offer loan forgiveness, cancellation, or discharge in certain circumstances. (You need to read the terms carefully and contact your loan servicer for more information if you think you are eligible.)
    • Public Service Loan Forgiveness: The remaining balance on your Direct Loans may be forgiven after you’ve made 120 qualifying monthly payments while working full-time for a qualifying employer.
    • Teacher Loan Forgiveness: If you teach full-time for 5 consecutive academic years in certain schools that serve low-income families, and meet other qualifications, you may be eligible for loan forgiveness up to a certain amount for certain types of loans.
    • For other types of loan forgiveness, cancellations, or discharge on certain federal student loans, see the chart and information here.

Consolidation and refinancing options

Other ways to pay down student debt

  • In addition to consolidation or refinancing, there are other things you can do to help pay down your student loan debt:
    • If you have multiple loans, rank them from highest interest rate to lowest interest rate, and go after the highest-interest loans first.
      • Some people prefer to pay down the lowest balances first so that they see progress, but you will save more in interest by paying off the highest-interest balances first.
    • Chip away at the student debt any way you can:
      • Cut back on expenses and try to find other ways to free up extra money that can be put towards your student loans. (See “Before you break the piggy” and “Savings Apps.”)
      • Take on a side hustle to bring in additional income.
      • If you are due (or overdue) for a raise or promotion at work, consider making a good case for yourself, being proactive, and seeing what you can get if you just ask.
      • If you receive a year-end bonus, commissions, deferred income, tax refund, or other one-time sum, resist the temptation to spend it. Consider putting it toward reducing your student loans instead (or other debt if that debt is at a higher interest rate).
      • Cut back on things like eating out, subscription plans, or other areas where you might overspend.
      • Try a staycation instead of spending money on a vacation with flight and hotel.
      • See if there are any items in your home that you don’t really need and that could be sold to generate additional funds. (See, e.g., Decluttr, Ebay, and CraigsList.)
      • Think about ways to reduce your housing costs even temporarily (getting a roommate if you don’t already have one, moving to a less expensive place when your lease is up, or moving back home, if that is an option).