If you’re looking to pay off past due accounts in order to help repair your credit, you’re going to have to tackle them one by one and come up with a repayment plan.
Any good repayment plan will follow these seven steps:
- List out all your debts
- Try to settle with your creditors
- Decide which debt to tackle first
- Create a budget
- Look for ways to earn extra money
- Seek help if you need it
- Start paying off your accounts
Why do we care about debt repayment when we’re trying to repair credit?
Because your payment history is the most important credit factor when it comes to calculating your credit score!
I will repeat: the most important factor.
So you need to get to a place where you’re paying your bills on time—and you can’t do that until you’ve first paid off your old accounts.
This guide lays out the process of how to do so in the most straightforward way possible.
Let’s get to work.
Step 1: List out all your debt
The first thing you’ll want to do is to make a list of all your debts, including:
- Amounts owed
- Interest rates
- Minimum payments
Why?
Because you can’t make a plan to pay it back if you don’t actually know what you owe! So you need to make an inventory of your debt.
When we say debts, what do we really mean?
Everything with a balance, minus your mortgage (unless you are behind on paying your mortgage, in which case you can add the total amount of late payments only).
Things like: credit cards, medical bills, student loans, and car loans.
It might look something like this:
Now that you have an inventory of your debt, it’s time to try to settle with your creditors first.
Step 2: Try to settle with your creditors
Before you begin tackling your debt, “one of the first steps you could take is to reach out to the creditor to see if it can help you get on a more affordable payment plan,” credit expert Louis DeNicola told us.
Basically, you can contact your creditors to see if you can reach some sort of settlement. This is especially true of credit cards and if you’re already in default and about to be turned over to collections.
Here’s how to do it:
Call each lender and explain your situation—let them know you’re working diligently to resolve your debt and ask them how they can work with you.
Many creditors will negotiate with you in several ways. For example, they might:
- Settle for a smaller amount to pay off the debt, especially if you can offer one lump sum
- Offer to knock off some interest in return for a quicker repayment
- Negotiate your payment amounts and agree to reduced monthly minimums
One quick tip: Be sure to ask for any settlement agreements in writing. This way, you can use it for leverage to dispute any collection attempts or credit report errors should they ever arise.
Why would a creditor settle with you, you might be wondering?
Most of the time, creditors realize their chances of receiving payment for delinquent debt are slim, and they’d rather get a portion of what you owe them than nothing at all.
Step 3: Decide which debts to prioritize
Instead of trying to pay down all your debts at once, we highly recommend attacking them one-by-one. This allows you to focus all your energy on one “goal” at a time, and once you’ve hit that goal (paying off that particular debt), it’s easy to move on to the next one.
So, how do you decide which debt to prioritize?
We’re big fans of two methods that actually have opposite approaches. We encourage you to read more about each one and decide which fits your personality best and then implement their strategies to start attacking your debts.
Here’s a quick overview of each strategy.
Debt snowball
The Debt Snowball is the brainchild of personal financial expert Dave Ramsey.
Here’s how it works:
You start off by tackling an account with the smallest balance first, while paying the minimum amounts due on all your other accounts.
For example, let’s say you owed $12,000 on your credit card (with a 20% interest rate) and $6,000 on your car loan (with a 6% interest rate).
With the Debt Snowball, you would throw all of your available money at paying off your car loan first before moving on to your credit card.
Why?
The reasoning is psychological: when you see that you’ve paid off one account all the way, it will keep you motivated to keep going, thus creating a “snowball” effect.
Debt avalanche
Another common method is called the Debt Avalanche, which is basically the exact opposite of the Debt Snowball.
With this method, you would pay off the account with the highest interest rate first.
So in our example above, you would pay off your credit card (and its 20% interest) first, while only making minimum payments on your car loan.
The idea here is purely mathematical: it minimizes the amount of interest you pay as you work on paying down your debt, and it shortens the amount of time it will take you to get out of debt since you are accruing less interest.
Again, which method you choose really depends on your personality — are you incentivized more by psychological gains or mathematical ones?
Step 4: Start a budget
If you’re already in a bind, chances are it’s because your expenses exceed your income.
Enter: the budget.
A budget will help you get to a place where you have more money coming in every month than you do going out—and the whole idea is that you can then use that extra cash flow to help pay down your accounts as part of your repayment plan.
This isn’t meant to be a step-by-step plan on how to start a budget, but let’s look at some key concepts:
Jotting down your take-home pay
You probably know how much money you make at your job … but do you really know how much money you’re taking home each month (after taxes, insurance, retirement, etc.?)
Figuring out your take-home pay is incredibly easy, but also very important and is our first step.
Just pull up your pay stubs for the last month—same with your partner, if applicable —tally them together, and now you know exactly what you’re taking home every month.
Let’s say between you and your partner, your household is taking home $4,500 per month.
This number will be important when we get to the next step!
Tracking your spending
You can’t get to a point where you’re earning more money than you’re spending if you don’t know a) how much you’re spending, and b) what you’re spending your money on.
So, you need to get a handle on your expenses. You can do this in one of two ways.
- Use an online budget template and track your expenses by hand. While you’ll get a better “visual” of where your money is going, it requires a lot of work to manually enter each expense by hand, and will probably result in you giving up.
- Use an online tool like Mint. Mint.com is free and it’s awesome. You link your debit and credit cards and Mint automatically starts to pull in all of your transactions. Then you can assign each expense a “category” (e.g., food, travel) and you’ll start to see what areas you’re spending your money on. Mint is easier and more accurate than doing this by hand.
Do this for a full month and you’ll get an idea of how much you’re spending each month.
Let’s say after a month you’ve added up everything and you ended up spending $4,900.
Well, in our example, this is $400 more than you earned for the month so you know you have some work to do!
In simple terms, your expenses should not exceed your income. That’s where actually creating your budget comes in.
Creating your budget
Now that you know how much total money you have at your disposal each month— $4,500, in our example—you can set out to make a budget that comes in lower than that number.
How do you actually create your budget? By listing out “buckets” of expenses and assigning a dollar amount to it.
This is much easier to explain by way of example, and giving you a visual.
With Mint.com, you can easily create a budget, and create “buckets” or categories for your expenses. Here’s a simplified version of what the beginnings of a budget might look like:
You can see for that first line item, “Home” is the main category and “Mortgage & Rent” is the sub-category.
So let’s say your mortgage payment was $1,200 per month — in Mint, or on your budget spreadsheet, you’d create a line item for “Mortgage” and assign it $1,200.
If you were doing this manually with a spreadsheet, it might look something like this (again, this is a dumb-downed, incomplete example):
You want to do this for every category and subcategory that you spend money on. And since you tracked your spending in the previous step, this should be pretty easy to do.
Here’s the key point, though: your budget needs to be lower than your take-home pay! So since you have $4,500 in take-home pay in our example, your budget cannot exceed that amount.
If your budget comes out higher than your take-home pay, you need to adjust the budget accordingly—maybe you allot less money to going out to dinner, for example—and then follow through on these adjustments with your actual spending.
Keeping yourself accountable
This is the part where a lot of people get tripped up with budgeting—they don’t have much trouble actually creating the budget, but when it comes time to review their progress, it just doesn’t happen.
You should check in and review your budget every single month — and continue to keep track of your expenses.
If you have $4,500 in total take-home pay, how much of that are you spending every month? Where is the money going? Where are some areas you can cut back on? What adjustments can you make?
Because every extra dollar you can save by cutting back on expenses equals an extra dollar you can use to start paying down your debts.
Step 5: Look for ways to make extra money
While finding extra money in your budget is one side of the coin, the other side is figuring out a way to add some extra cash to your bottom line with a side hustle.
There are a ton of things you can do to earn extra money, either online or by doing a “gig”, such as:
- Filling out online surveys
- Driving for Uber or Lyft
- Cash back apps
- Walking dogs
- Delivering food with PostMates or UberEats
- Freelance writing
- Starting a blog
You’re not going to replace your full-time job, but you can earn a meaningful enough income where it allows you to pay off your debts faster, which is the entire point.
Step 6: Get help if you need it
If you find yourself in serious trouble, you can reach out to a non-profit credit counseling agency for help. “These organizations can negotiate with your creditors on your behalf and may be able to help you get on an affordable payment plan,” DeNicola said.
They may also offer free workshops and resources and may be able to help you create a budget.
One thing to note: most credit counseling organizations are “non-profit”, but that doesn’t necessarily mean their services are free.
The Department of Justice has a list of approved credit counseling agencies on their website that you can check out for organizations in your area.
You do have to be careful when working with these agencies though, and you should research the companies you contact to make sure they’re legitimate.
The FTC has a good guide on how to choose a credit counselor, as well as a list of questions you should ask before deciding to take them up on their services:
One service a credit counseling agency may recommend is enrolling in a debt management plan (“DMP”), which is designed to help you come up with a repayment plan for your debts.
The same FTC guide covers how to decide if a DMP is right for you, and we highly recommend checking it out if you’re interested in looking into a DMP any further.
Step 7: Start paying off your accounts
Ok, up to this point you should have:
- A list of all your debts
- A plan of attack for which ones to pay off first
- A little extra money from cutting back expenses and earning extra income
Now comes the easy (and fun) part—actually paying off your accounts!
This is not any harder than it sounds.
If, for example, you decided to go with the Debt Avalanche approach and pay down your account with the highest interest rate, then you simply take the extra money you have from Steps 4 and 5 and start making additional payments to that account.
You keep doing this until that account is paid off in full.
Then, you move on to the account with the next highest interest rate and do the same thing—rinse, repeat. And keep going until all your accounts are either paid off in full or at least on time.
