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How to Pay Off Debt On a Low Income
By Peter Burns MONEY RESEARCH COLLECTIVE
Being in debt can be unnerving, especially if you aren’t a high-earner. Finding a way out of debt is a common challenge that many people face. By taking a strategic approach to your debt problem, you can find the right way to conquer your debt. This article goes over how to pay off debt on a low income.
How to pay off debt while earning a low income
There are many different approaches to getting out of debt. Some approaches are easier or more effective than others, depending on each person’s financial situation. Here are some debt payoff strategies that may help you improve your finances.
No more new debts
One of the most crucial steps for eliminating your debt problem is not to take on any new debts. Taking out a loan or signing up for a new credit card to relieve immediate stress will add more stress down the road as your credit card debt increases.
Using payday loans to tide you over can be especially damaging to your future. Companies market payday loans as convenient ways to get you through to the next paycheck but often trap people into debt cycles due to their high-interest rates. Likewise, putting a low-cost item on your credit card may seem convenient when you’re low on cash, but it will cost you a lot more once the interest kicks in.
Confirm how much you owe with each creditor
To find a solution to your problem, you need to know exactly how much you owe to each creditor. Make a list of every debt you have with the different interest rates and any penalties or late fees. Some examples may include:
- Credit card balances
- Medical bills
- Mortgage loan
- Personal loans
- Utility bills
- Auto loan
One way to get a snapshot of your debt is by searching for your credit report online. Your credit report will list your debts by lender or loan amount. A credit report is a great place to start your list, but credit reports aren’t always up to date. Update your list to make it as accurate as possible.
Identify opportunities to reduce monthly expenses and spending
Cutting costs is a critical method for getting rid of your debts faster. Keep track of what you spend over a month and analyze your expenses. You may see some costs you can cut down on to save money. Some ideas for saving money include:
- Cooking at home instead of eating out
- Switching your phone plan
- Using free WiFi instead of data
- Taking public transportation
- Making coffee at home
- Using coupons at stores
Look through your credit card bills to ensure websites and mobile apps aren’t charging you subscription fees for services you don’t use. Consider ending the subscriptions you don’t use very much. Some apps come with free versions with ads. It may be worth downgrading to those plans to save a little bit more money each month.
Determine how much you spend on rent and transportation and see if there are ways to minimize those expenses. Moving to a smaller apartment for a year or two might be a good idea until you settle your debts. You may also trade in your automobile for a cheaper or more fuel-efficient car to reduce expenses.
Draft a budget plan
Developing a realistic debt payoff plan that you can stick to is necessary to get yourself out of debt on a low income. The first thing you should do is list your minimum monthly needs. This list should include basic living expenses like rent or housing payments, groceries, transportation, monthly payments and additional necessary costs.
Once you have totaled your basic expenses, list your income sources and subtract the two totals. You split up the remaining money for your debts, wants and savings. Be consistent once you’ve determined how much you will allocate to paying debt collectors each month. Always pay at least the minimum sum you’ve decided on, but add more when you are able.
Putting most of the remaining sum towards your debt may be tempting, but it may be beneficial to put a percentage aside each month into an emergency fund. No matter how small, an emergency fund can relieve stress and help you get out of debt. In the case of an emergency or unexpected event, you won’t need to take out more debt to deal with it. Instead, you can take money straight out of your emergency fund and continue lowering your debts.
Use the debt snowball method
The debt snowball method is a strategic way to deal with debt. Instead of paying all your debts evenly, snowball debt payoff has you pay off the smallest debt first. Once you completely pay off your smallest debt, you can focus on the next smallest debt. By seeing your debts disappear one by one, you will gain momentum and feel more motivated.
Another debt strategy is called the avalanche method. The avalanche debt payoff has you pay off the debt with the highest interest rate first. Like the snowball method, once you pay off the debt with the highest rate, you allocate those funds to the debt with the next highest interest rate. By eliminating the higher interest rates first, you are lessening the overall debt you will have.
Take up a side hustle or ask for a raise
Cutting your spending can help improve your debt situation, but having more money coming in is the best way to pay off your debts faster. Finding a side hustle or an additional income stream is the most effective way to decrease your debt. Even if you don’t have much extra time to devote to a side job, any extra money that you make can help you control your debts. Some possible ways to make extra income are:
- Rent out a spare bedroom
- Become an online coach
- Write an affiliate marketing blog
- Have a garage sale
- Drive for a ridesharing company
- Babysit on the weekends
- Find a part-time job or seasonal work
- Become a dog walker
Consider asking your boss for a raise as well. If you cannot get a raise, you could search for a better job with a higher salary to help you control your debt.
Negotiate better interest rates
You may be able to negotiate with your debt collectors for a better interest rate to figure out your debt problems faster. This tactic can work if you’ve been up to date on your debt payments and are in good standing with the creditor. Negotiations don’t always pan out, but it is worth a shot. If you can negotiate a lower interest rate on your current debt, you’ll be able to pay the balance down faster.
Build good credit
Having a good credit score is always important, but it can be especially beneficial if you are in debt. With a low credit score, you will pay higher interest rates. High interest adds to the amount of debt that you already have. If you only make the minimum payments on a high-interest loan, you may only be paying off your accrued interest and none of the principal. It is impossible to get out of debt this way.
Even with a large debt, there are ways to build up your credit score over time. Some ways to manage your credit score include:
- Check your credit score regularly
- Remove charge-offs from your credit report
- Make monthly payments on time
- Dispute credit report errors
- Don’t apply for new credit accounts often
- Remove collections from your credit report
- Keep your credit utilization under 30%
Consider other debt relief options
There may be a point where you’ve done everything you can and still have serious debt problems. If you cannot cut your spending anymore and don’t have any extra time to earn more income, you may need to look at other debt-relief options.
Debt consolidation loans
A debt consolidation loan may be helpful if you’re feeling overwhelmed by bills coming at you from all angles. Debt consolidation works by paying off all of your debt with a single loan, so you only need to pay one source each month. Ideally, the best debt consolidation loans will have a lower interest rate than your other debts so that you can pay off the balance more easily. Having a good credit score can help you get a low-interest rate.
Most low-income debt consolidation loans are unsecured, which means they are not backed by any collateral and may have a higher interest than a secured loan. One type of secured loan is a home equity loan, which is backed by your house. Because you’re using your house as collateral with a home equity loan, you can usually get a lower interest rate than you can with a personal loan. The drawback of using your home as collateral is that you could lose your house if you cannot make the necessary payments.
Debt management plan
Another debt relief option is to speak with a credit counselor. Credit counselors are part of a non-profit organization to help customers improve credit scores or deal with debt issues. The first consultation is usually free, and they can help you set up a debt management plan (DMP).
A DMP can last three to five years. Credit counselors may be able to help you negotiate lower interest rates with some of your creditors or get creditors to stop collection efforts and late fees while you are on the plan. Make sure to research your options, as credit counselors and DMPs sometimes require monthly payments.
Balance transfer credit card
Like using a debt consolidation loan, you can try using a debt consolidation strategy with a credit card. By paying off all your debts on a single balance transfer card, you will have the same advantage of only having one bill to pay. These cards often come with balance transfer fees of 3% to 5% but may offer 0% APR for as long as 21 months, giving you a great window to pay off your principal.
Debt settlement companies
If you’re running out of options, you may want to look into debt settlement companies. These companies will help you with debt forgiveness, but it often negatively impacts your credit report. Debt relief companies will negotiate with your creditors on your behalf and try to lower your balance. These companies will usually ask you to stop making payments for some time to gain leverage. This strategy may convince your creditors that you cannot make payments as agreed upon and cause them to lower your balance so they can receive some payments instead of nothing.
Although it is possible to lower your balance, these missed payments will show up on your credit report. Keep in mind that results are not guaranteed, and there is a possibility that you will miss payments and lower your credit score only to end up back where you started. Companies that offer low-income debt relief are for-profit companies, so you will need to pay them a fee.
Bankruptcy
Bankruptcy is a way to get out of debt but should be a last resort. Depending on the type of bankruptcy you employ, you will have negative information on your credit report for the next seven to 10 years. The most common forms of bankruptcy for individuals are Chapters 7 and 13.
Filing for Chapter 7 bankruptcy means a court-appointed trustee can sell all of your assets deemed non-exempt by the court to pay back your creditors. With Chapter 13 bankruptcy, you will draft a repayment plan that you will need to stick to for the next three to five years and pay back 100% of your debt. If you think bankruptcy may be your best option, speak with a bankruptcy attorney familiar with your state laws first.
Know how much debt you can afford with the debt-to-income ratio
Whether you are in a lot of debt and feel overwhelmed or have managed your debt well and feel in control, it’s an excellent idea to know your debt-to-income ratio (DTI). The advantage of knowing your DTI is that you can determine your debt comfort level. Future lenders will also look at your DTI to determine how much risk will be involved with taking you on and lending you money.
To calculate your DTI, add up all of your monthly bills and divide that total by your gross monthly income before taxes. The result from this equation is your DTI, which will be a percentage. The lower your DTI, the less of a risk you are to lenders. No matter your debt situation, you should try to get as low a DTI as possible.
Don’t let low income keep you from your debt payoff goals
Debts are complicated, but by finding a strategy that works for you and sticking to it, you can get out of debt and meet your financial goals even if you have a low income. Cutting non-essential spending, finding a side hustle, making a budget, improving your credit score and considering debt relief options are all ways to find a way out of debt. Use one or multiple approaches until you find the best debt-reducing option for you.