How To Pay Off Debt: A Complete Guide

Understanding how to pay off debt has never been more important.

Contents

• Understanding Debt
• Common Types of Debt
• The Practical Impacts of Debt
• The Emotional Impacts of Debt
• Dealing With Debt: Budgeting
• Dealing With Debt: Negotiating With Creditors
• Dealing With Debt: To Snowball or Avalanche?
• Debt Settlements and Bankruptcy
• Strategies for a Healthy Financial Life
• It is Possible to Become Debt Free

Understanding Debt

In 2022, American household debt increased to$16.9 trillion, a rise of $2.75 trillion since 2019. Consumer debt includes everything from credit cards and overdrafts to mortgages, student loans and car loans.

Considering a mortgage or student loan as investments, you invest in your future through certain forms of debt. You need to live in housing, and an education should increase your future earnings. Other forms of debt, such as short-term loans and credit card debt, are less desirable. These debts often come with hefty interest charges and late payment fees, making them costly options. If a person’s monthly payments towards consumer debt become too large a portion of their regular income, the financial stress may negatively impact their physical and mental well-being.

Debt is something that many people struggle with. However, thegender wage gapmeans women sometimes find it more challenging to service their debts because repayments take up a more significant percentage of their earnings.

Eliminate Debt and Save For Your Future

Being in debt can be stressful for several reasons:

• While you’re paying back debt, you’re essentially working to pay for a past purchase or experience
• Late payment fees can make it take even longer to pay back your debt
• The money that goes towards servicing your debts is money you can’t save for your future
• If you’ve had to borrow once to cover living expenses, servicing that debt could leave you short the next month

Slow and Steady Wins the Race

If you’re in significant debt today, becoming debt-free may seem out of reach. However, time spent now to clear your debt and learn new financial habits will pay off over the years as you save for retirement. Once you’re debt-free, you’ll find more funds available to save and spend on improving your current lifestyle.

Paying off your debts could help reduce stress in daily life. Improving your cash flow can leave you in a better position to handle emergencies such as a broken car or household appliance. You’ll be able to redirect money that used to go to loan or card payments towards savings and investments, giving you a more financially secure future. Depending on your debt level, it could take several years to clear it all. But in time, you’ll build good habits that you can continue to practice as you save for retirement.

In this guide, we’ll look at the different kinds of debts people tend to have, how those debts might impact your life and which ones are the most important to clear. We’ll also look at some strategies for addressing debts depending on your current circumstances. If you can make payments, we’ll help you prioritize them. If you cannot keep up with the payments your creditors expect, we’ll offer some suggestions for dealing with that issue.

Everyone’s financial circumstances are different, but the goal of this guide is to help you understand where you stand and create a plan that will put you on the path to being debt-free and staying debt-free. The journey to financial stability may take a long time, but your future self will thank you for it.

Common Types of Debt

Debt comes in many different forms, and not all debts are as serious as others. While it may be intimidating to look at a large mortgage or a five-figure student loan, those debts are an investment in your future, and they also aren’t generally things that will have a considerable impact on your credit score.

Yes, it’s good to pay those debts off, but the most serious debts are things like rent arrears, unpaid taxes or utility bills. Neglecting to stay current with these matters may result in losing your home, experiencing power disconnection, or facing legal fines.

The next most serious category is consumer debt because these debts tend to have the highest interest rates. Clearing these will have the most significant impact on your financial stability. Let’s consider each in turn.

Consumer Debt

This category covers things like credit cards, personal loans, payday loans and store cards. These debts tend to be short-term but have high-interest rates. It’s quite easy for someone to end up borrowing thousands of pounds over a few different store cards and credit cards, only to find they’re struggling to pay off the debts due to a change of circumstances or because they hadn’t realized they were using the cards to live beyond their means.

If you’re in serious financial difficulty and unable to make payments, focus on priority debts first, and negotiate with these creditors to find a manageable repayment plan.

Student Loans

Student loans are the first exposure to debt for many people. If you needed to take out a loan to cover your tuition fees and living expenses while you studied, graduating with a substantial debt may seem intimidating.

Depending on the career you chose, you may be able to take advantage of loan forgiveness programs. For example, thePublic Service Loan Forgivenessplan offers loan forgiveness to people who have made 120 payments under a qualifying repayment plan while working for certain kinds of employers.

Student loans are a debt; as such, they reduce your available income each month, so it makes sense to want to repay them as quickly as possible. However, federal student loans offer short-term deferment options, and private loan providers may also offer relief plans, so those who have fallen on hard times may be able to get help from their lender while they get back on their feet.

Mortgage Debt

View mortgage debt for your primary residence as an investment, as it stands among the few types of debt with such potential. When you take out a mortgage, you’re borrowing money to buy a place to live. The goal is to live there while that property increases in value. You’ve fixed your monthly payments at a certain amount, and while making those repayments, you’re building equity in the property.

Over the long term, having a mortgage is probably a better financial choice than renting if you can keep up with your mortgage repayments. If you don’t, the mortgage lender could repossess your home.

Once you fall into arrears with your mortgage, it goes from an acceptable debt to a priority one.

Priority Debts

Priority debts are ones you must cover because failing to do so could have serious implications for you and your family. Debts that fall into this category include:

• Rent or mortgage arrears
• Unpaid taxes
• Fines
• Unpaid utility bills
• Car loans (if you need a vehicle to get to work)

If failing to pay a debt would cause you to lose your home or vehicle, have your utilities cut off, or lead to you being arrested or having your wages garnished, this debt should be treated with urgency.

The above creditors are some of the ones that it’s important to prioritize paying if your income falls or you’re otherwise in a situation where you can’t pay all your bills. Keeping a roof over your head and the lights and heating working is essential.

Business Debt

Business debts are a complex issue. Depending on the legal structure of your business, it could be that winding up the business would clear the debts. Alternatively, the creditors may be able to pursue you as an individual for any unpaid bills.

Addressing these issues is beyond the scope of this guide. If you have a business and cannot pay your creditors, seek financial advice from an organization such asDebt.org.

The Practical Impacts of Debt

Debt can be useful if it’s entered into for the right reasons and the payments are manageable. However, if someone takes out debt to fund short-term purchases or living costs, they could find themselves trapped in a cycle where they always have to borrow to service that debt and cover their short-term costs.

Even in cases where the initial debt was for an important purchase or asset with long-term value, it’s possible for someone to find themselves in financial difficulty when they’re paying off that debt. Sickness, unemployment or changing family circumstances could turn a previously manageable debt into a crisis.

The Financial Impact of Debt: Credit Scores

Lenders make money by charging people interest on the money they borrow. To ensure they make money, the interest they charge has to be enough to cover the costs of running their business and loans to people who default on their debts. Lenders determine how high risk a person is based on their credit scores.

People with a good track record of paying their bills on time and who have some credit but aren’t using up all their available lines of credit tend to have good credit scores. There are several different credit reference agencies. The main ones areExperian,EquifaxandTransunion. While each of these employs a slightly distinct scoring approach, in most instances, someone deemed low risk by one agency would receive a similar rating from the others; the same applies to a higher-risk borrower.

When someone takes out a car loan and makes their payments on time, they may notice that their score goes up. The same applies to the first credit card someone takes out. Taking out a card and paying off more than the minimum monthly payment is a sign of financial stability and responsibility.

More Is Not Always Better

There are limits to this, however. Having just one well-managed card is the easiest to make positive. Possessing two can also be advantageous. Yet, borrowing more or using various financial products might lead to a higher risk perception by credit agencies and lenders.

The methods used to calculate credit scores are complex and consider numerous pieces of data, but one key thing they consider is your debt-to-income ratio. People with a high debt-to-income ratio usually have poorer credit scores.

One common rule of thumb used by lenders is that people shouldn’t have a debt-to-income ratio of more than 43%. If you have an income of $40,000 and debts of $20,000, that puts you at a debt-to-income ratio of 50%. There’s a high chance that you’re putting much of your monthly income toward servicing your existing debts. It’s only logical that lenders would worry about whether you could make your monthly payments to them if they were to choose to lend to you.

If you miss payments, make them late, or consistently pay only the minimum payment on your credit cards, this will also negatively impact your credit score. To credit reference agencies, someone who chooses to make the minimum payment each month, therefore paying more interest, is probably already under financial stress and may struggle to service additional loan payments.

High-Risk Borrowing Costs More

When your credit score falls, you’ll find some lenders don’t want to work with you. This doesn’t imply that individuals with poor credit scores are entirely disconnected from the financial system. Some lenders specialize in high-risk loans and offer credit cards to people with poor credit.

The issue is that these lenders tend to be expensive. They charge high-interest rates and may also have punitive fees for late or missed payments. They’re also likely to offer smaller loans or lines of credit and expect them to be paid back quickly.

This could be seen as a good thing because it discourages those who are likely to struggle to make payments from borrowing for non-urgent reasons. However, it also means those in a less financially stable position can’t access financial help when needed.

A person with a good credit score whose car develops an expensive fault or whose HVAC system fails can put the repair bill on a 0% credit card and pay it off in small chunks over a year without penalty. Someone who is already financially struggling doesn’t have that luxury and will end up paying interest on any money that they borrow.

AsTerry Pratchettexplained in “Captain Samuel Vimes ‘Boots’ Theory of socioeconomic unfairness” in the fantasy novel “Men at Arms,” it’s expensive to be poor.

If you’re in debt to the point that you can’t save for an emergency and a large portion of your income is going towards servicing your debts, it’s a good idea to prioritize getting out of debt. Once those debts are cleared, it will feel like you’ve just received a hefty pay rise.

The Emotional Impacts of Debt

Debt doesn’t just impact your bank balance; it can have a significant impact on your physical and mental health, as well as on your relationships. The emotional impact of debt is becoming increasingly apparent as the cost of living increases and more people who were “comfortable” suddenly struggle to pay their bills.

Debt and Stress

Dealing with debt can be incredibly stressful, especially if the debts in question include rent, mortgage arrears, or other “priority debts.” However, even consumer debt can be difficult to deal with. According to one 2020 study, credit card debt is the greatest indicator of financial strain.For every $10,000 owedon credit cards, the likelihood of a person reporting financial strain increases by 65%.

It should come as no surprise, then, that around 40% of consumers say that credit card debt has had a negative impact on their happiness, and 20% say it’s been harmful to their health.

If you’re worried about how you’ll pay this month’s bills, fearful of losing your job because your family has no financial cushion, or feel guilty about even the smallest expenditure because you’re in debt, this is a sign that your debt is causing you stress.

Long-term stress can harm your health and increase the risk of substance abuse and other mental health issues. It can even exacerbate physical health conditions. Individuals experiencing stress or grappling with anxiety might have a higher propensity for encountering problems such as weight gain, elevated blood pressure, or a compromised immune system.

Taking back control of your financial well-being may not solve all of the stresses in your life, but it can certainly go a long way toward mitigating them.

Relationship strain

Being in debt can place a considerable strain on a relationship. According to one recent survey, more than one-third of peopleblame finances for the stress they experience in their relationships. Debt is a common cause of infidelity and divorce, and relationships where people have very different attitudes to money, tend not to last as long as ones where people are on the same page. If one person wants to save for the future and the other is looking to spend on experiences today. This could lead to arguments if the people involved aren’t able to come to a compromise.

While attitudes to money and debt have changed in recent years, some cultures still have a stigma surrounding debt. People who struggle to manage debts may feel ashamed of those debts and feel the need to hide them. It doesn’t matter whether the debt came from gambling, discretionary spending, a failed business or simply struggling to make ends meet; they feel that it’s their sole responsibility and that their partner may think less of them if they find out about the debt.

This unfortunate attitude makes it much more difficult for people to tackle their financial issues. It also puts extra strain on the relationship. The partner with the debt may feel stressed, and their partner doesn’t understand why. They may make plans to spend money and feel confused when the other partner shuts those plans down. Discovering the concealed debt typically results in feelings of betrayal and eroded trust.

Communication Is Key

In any long-term, committed relationship, communication is important, and if that communication includes sharing information about finances, this may help people cope better with financial stress.

Whether or not a couple chooses to have a shared bank account is up to them. Some couples pool their finances, and others split bills equally or based on their individual incomes. No approach is right or wrong as long as both parties in the relationship are happy with it. However, clear communication about finances can greatly reduce stress on a relationship.

Once the burden of debt is out in the open, the couple can work together to solve the issue more easily.

Dealing With Debt: Budgeting

If you owe money and worry that your debts are getting out of control. The first step is to get a true picture of where you stand and work out a budget. Only once you know exactly how much you owe and your income and outgoings can you start to address the problem.

Building a Budget

Do you know where your money goes each month? Many people think they do but find themselves running low on funds as their next payday approaches, then wondering where the money went.

Take a moment to write out a simple budget. You can use a Google Sheets spreadsheet for this or take out a free trial of an app likeYou Need a Budget. In this budget, make a note of absolutely everything you can think of:

• Your minimum payments toward your debts
• Rent
• Taxes
• Travel costs (whether that’s a public transit pass or car costs)
• Groceries
• Utility bills
• Phone/internet bills
• Entertainment subscriptions (e.g., Netflix or Spotify)
• Spending on after-school clubs for kids
• Gym memberships
• Clothing, haircuts
• Socializing

If your outgoings are higher than your income, you’ve spotted an obvious problem. If they’re lower than your income, but you usually find yourself running out of money each week or month, take a look through your bank statements and see what else you’re spending money on that you’ve overlooked.

Once you have a truthful idea of your budget, the next step is to work out where you can save money.

Identifying Unnecessary Expenses

If you’ve noticed that your regular expenditure is more than your monthly income or is very close to your monthly income, you’ll need to find ways to cut costs. Depending on how much money you need to free up in your budget, this could be easy to do, or it may require making some changes to your lifestyle. Some options include:

• Use price comparison sites to shop around for cheaper utilities/phone/internet
• Change tiers on your services if you aren’t taking advantage of everything offered on the top package
• Look at carpooling rather than driving to work every day
• Cancel unused subscriptions (Why pay monthly for Amazon Prime if you rarely buy from them?)
• Consider buying groceries in bulk or changing to less expensive brands
• Take lunch to work rather than eating out

Each of these options might save only a few dollars, but together, they’ll add up and could help you get debt-free more quickly.

Depending on your debt level and current credit score, you may be able to get some breathing space with your debts by consolidating higher-interest loans or transferring debts onto a 0% credit card.

Consolidation Loans and Balance Transfers

The purpose of consolidation loans is to make debt repayments more affordable. Let’s imagine you have a $1,000 loan, a $2,000 credit card, and a $1,000 credit card; the combined repayments are $500 per month. You’re struggling to make that repayment, so you look for a consolidation loan.

You find a lender offering a loan at a rate of $120 per month over five years. Which is comfortably within your budget. You take out the loan, have a single monthly payment to make and can sleep easily at night once again.

Consolidation loans can look like the perfect solution to your problems. However, they’re often expensive. Our quick example works out to around 15% interest. So you’ll end up paying more than $2,100 in interest over the loan’s lifespan. If your previous loans and cards were at a lower rate, you’re overpaying. If you’re considering between defaulting on loans with late fees or a consolidation loan, the latter might be cheaper. Yet, focusing on clearing loans swiftly remains the wiser choice.

Balance Transfers Can Be An Option

Balance transfers could be an option for those with a good credit rating. Many banks offer 0% credit cards to which you can transfer other credit card balances. You’ll pay no interest on the balance transfer for a fixed period.

If you know you can pay off the card within that fixed period (usually one year). A balance transfer can give you some breathing space and be a cost-effective method of managing your debts. However, it’s important to remember that balance transfer cards aren’t to be used for purchases or cash advances because those transactions are charged at higher interest rates. In addition, when the 0% period ends, the interest rates on those cards may be much higher than those on a standard card.

Moving Debts Is Only Part of The Solution

Loan consolidation and balance transfers can be useful short-term solutions to give you some breathing space if you struggle to make payments. The issue with these solutions is that they don’t solve the underlying problem.

If you consolidate your credit card debt and then continue to use your cards, you’ll end up with even more debt. If you move costly credit card debt onto a 0% card, then only pay the minimum on that card and spend the extra money in your budget on living expenses, you’ll find yourself struggling financially again when the interest-free period runs out.

That’s why it’s essential to make a budget and stick to it when tackling your debts. If you’re lucky enough to be in a position where consolidation is an option, building good financial habits will make life much easier for you in the long term.

Unfortunately, not everyone is in a position to explore these options. If your debts are larger or you don’t have the income to cover them, you may need to negotiate with your creditors to reduce your payments or freeze the interest. We’ll discuss those options in the next chapter.

Dealing With Debt: Negotiating With Creditors

You’ve drawn up a budget, shopped around to cut costs on necessities, canceled lots of subscriptions, and cut as many luxuries as you can from your shopping basket. However, you’re still short several hundred dollars per month, and you can’t find any lender that’s willing to offer a consolidation loan you can afford. What do you do?

It can be tempting to bury your head in the sand, but all that will lead to is more stress when reminder letters turn to persistent phone calls and doorstep callers. As hard as it may be, the next step is to call your creditors.

Sit down with your budget and your list of debts. Ensure you’ve covered your priority bills and call the other creditors.

What Happens When You Call a Creditor?

Most creditors will be happy to hear from you. In their view, a customer who is proactive enough to call and say they’re experiencing financial difficulty is unlikely to become delinquent. If your financial issues are short-term, they may be willing to give you a repayment holiday or freeze interest for a while.

If your issues are longer-term, they’ll want to discuss your finances with you and work out a payment plan. To do this, they’ll need to know:

• Your monthly income
• The source of that income (wages, pensions, benefits)
• How much of your income goes on priority expenses
• If you have any savings
• How much you owe to other creditors

Based on that information, they’ll consider a payment plan. You’ll likely be offered a plan for a few months, and then they’ll want to review it and find out if your circumstances have changed. If you have a lot of creditors and you’re currently unemployed or unable to work due to illness, you may end up paying just a dollar a month to each creditor. Keep up with those payments while you seek advice about your longer-term options.

If you’re in a slightly better position than that and you can re-negotiate your loans over a longer period or have the interest on your credit cards frozen, that could be enough to set you on the path to clearing your debts. There are a couple of different approaches to dealing with debt, and you’ll need to sit down with an online calculator or spreadsheet to work out which one is best for you.

Dealing With Debt: To Snowball or Avalanche?

If you have enough money to service your debts, consider the order in which you pay them off. There are two popular approaches to paying off debts: thesnowball methodand theavalanche method. The snowball method works by prioritizing smaller debts, giving you the satisfaction of ticking off debts as they’re cleared. The avalanche method prioritizes the highest interest rate debts, potentially saving you money in the long term.

Let’s imagine that you have the following debts:

• Car Loan:$15,000 at 5% with a minimum payment of $500 per month
• Credit Card A:$2,000 at 35% with a minimum payment of $200 per month
• Credit Card B:$500 at 18% with a minimum payment of $20 per month
• Bank Loan:$5,000 at 8% with a minimum payment of $100 per month

You can afford to pay the minimum payments on all of these debts. You’re up to date on your taxes and rent or mortgage, so you don’t have to worry about penalties. After working out a household budget, you determine you can afford to pay an extra $100 per month to clear your debts, but you’re unsure which debts to prioritize.

The Debt Snowball Method

The debt snowball method works by paying off the smallest debts first. So, you’d make minimum payments towards the car loan, your bank loan, and Credit Card A while pouring the extra $100 per month into Credit Card B until that’s paid off.

Once that’s paid off, you’d have $120 per month (the $20 minimum from Credit Card B, plus your $100 overpayment) to put towards the next-largest debt. In this case, Credit Card A. So, you’d be making payments of $320 per month towards that card.

Note that the minimum payment on your statement with credit cards may change monthly as your balance reduces. When using the snowball method, you have a set budget to pay per month towards your debts. You can make whatever the minimum payment is on each of your larger debts, but you’ll pay all of the remaining funds towards the smallest debt until it gets cleared.

Why Choose the Snowball Method?

The snowball method can be useful for some people because it helps them stay motivated. In the above example, overpaying on the smallest credit card means it will be paid off within about five months. Some people find it quite satisfying to strike a debt off their list.

After that first debt is paid off, the extra money can be directed to the second credit card, increasing the payments being made on that card by more than 50% and making that balance tick down more quickly.

The snowball method makes it easier to see the metaphorical light at the end of the tunnel. It’s also useful for people struggling to juggle payment dates or who find dealing with multiple creditors overwhelming. Because the list of creditors is being reduced quickly, the number of outgoing payments is also reduced quickly.

The Downsides of the Snowball Method

The downside of the snowball method is that while it works as a psychological trick for some people, there are more financially efficient ways to pay off debts.

In the above example, you’d be spending a few months paying down an 18% debt when you have a much larger debt that’s building up interest at a rate of 35%. Over the long term, you’d pay less interest if you prioritized Credit Card A to reduce that balance as quickly as possible.

In fact, that’s what the debt avalanche method would recommend.

The Debt Avalanche Method

If you have high-interest rate debts and you’d like to reduce the interest you pay over the lifetime of the debt, choosing the debt avalanche method instead of the snowball method could be a wise move.

The debt avalanche method focuses on paying down the highest interest-rate debts first. So, using the above example, you’d pay $300 per month towards Credit Card A (the $200 minimum and the $100 extra) while paying the minimums on the other debts.

If you ever have an opportunity to reduce payments on the other debts (for example, if Credit Card B’s minimum was reduced to $15 as the outstanding balance fell), you’d redirect that $5 in your budget towards Credit Card A. Even small overpayments can help.

Using this approach, you’ll pay less interest on Credit Card A and pay it off more quickly. Once that debt is paid off, you’d work through the list, paying off Credit Card B next because that has the next highest interest rate. Following that, you’d tackle the bank and car loans.

Why Choose the Debt Avalanche Method?

Depending on the sizes of your debts, and the amount of interest being charged on each one, the debt avalanche method could save you a lot of money over the lifetime of your debts. In this example, the highest interest rate debt is relatively small and is paid off quite quickly, making any difference in interest negligible.

If the outstanding balance on Credit Card A was much higher, the avalanche method could save you a lot of money in the long term, compared to overpaying lower-interest debts first.

The Disadvantages of the Debt Avalanche Method

Depending on the sizes of the debts in question and how interest is added to the account, the debt avalanche method can feel demotivating for some people. Instead of seeing a rapid decrease in the balance of some debts and having the satisfaction of ticking off debts as paid off every few months, you spend the first few months (or longer) chipping away at a debt that has significant amounts of interest added.

The Best Method is the One That Works For You

Both the debt snowball and the debt avalanche methods are effective, and choosing the right one for you comes down to finding the balance between psychology and practicality. If you know you need the motivation to see debts fall quickly, the snowball method may be best. If you’d feel happier knowing you’re not “giving interest away,” choose the avalanche method.

These two methods are named after the way the debt payments grow. With the snowball, you start out clearing small debts, and then the financial snowball gets bigger and bigger until you’re putting a large payment on a large debt, and you can see the impact.

The avalanche starts out as a trickle, chipping away at the interest, but once that high-interest rate debt is gone, the avalanche can be big and powerful, clearing large debts quickly.

The biggest impact of both of these methods comes from overpaying. They can take years to clear if you only pay the minimum on your debts. Even a small overpayment could knock months off the time it takes to be debt-free and save you money on interest.

Debt Settlements and Bankruptcy

Not everyone is in a financial situation that allows them to pay down their debts using the snowball or avalanche method. If you can only put $50 a month or less towards a substantial debt, it could take decades to clear what you owe. Fortunately, you don’t have to accept a lifetime of debt.

Debt settlement companies specialize in negotiating settlements for people who can pay some of what they owe but aren’t in a position to clear the entire amount, and bankruptcy offers a chance at a clean slate for those who simply cannot see another way to clear their debts.

Understanding Debt Settlement

Debt settlement companies may be useful if you have a lump sum of money available and a substantial amount of consumer debt that you feel you can’t clear. This may happen if you’ve been made redundant and received a severance payment or if you’ve received an inheritance, for example.

Debt settlement companies take the stress out of dealing with your creditors. They’ll negotiate with each creditor for you and try to arrange a settlement. They’ll usually charge a fee for doing this.

Debt settlements will resolve your debt situation, but you will be left with a mark on your credit file. Suppose a creditor knows that you’re struggling financially, and they’ve seen that you’ve missed payments or been late with payments. In that case, they may be willing to work with a debt settlement company and offer a discount as high as 50% or even 70% on the debt because they’d rather get some money from you now than have to spend money chasing up late payments later should your financial situation get worse.

If you opt to go the debt settlement route, you can use your lump sum to pay off your debts and have the creditor note on your file that the debt is no longer outstanding but was not paid in full.

This could affect your ability to borrow money in the next few years. However, if you’re trying to take control of your finances, you most likely won’t want to fall into the debt trap again.

Is Bankruptcy Right For You?

Bankruptcy is a last resort for people and companies that cannot pay off their debts. When a person is declared bankrupt, their unsecured debts are wiped out, and they’re essentially given a fresh start.

There are many different kinds of bankruptcy, but most individuals will go through Chapter 7 or Chapter 13.

Chapter 7 Bankruptcy Explained

As a part of Chapter 7 bankruptcy, a court-appointed trustee will liquidate any assets you have and use those to pay creditors. Any remaining consumer debts, such as credit cards or loans, will be erased. Student loans and taxes will persist through bankruptcy.

In most states, you’ll be allowed to keep your home, a vehicle you need to get to work, and your retirement funds, but any other assets will be sold. If you want to keep any assets, you’d need to reaffirm the debt and continue making payments.

Most Chapter 7 bankruptcies are entered into by people with no assets and very low incomes. The process is means tested, and those who the court deems as able to make significant payments towards their debts wouldn’t qualify for a Chapter 7 bankruptcy.

Chapter 13 Bankruptcy Explained

In a Chapter 13 bankruptcy, the court determines how much you earn and then determines what you can afford to pay your creditors. They’ll then set a payment plan that will run for between three and five years. As long as you stick to the repayment plan, any remaining debts will be wiped out.

Chapter 13 bankruptcy allows people to keep their assets and gives them breathing space to catch up on the payments for any debt that can’t be erased through bankruptcy. It can also help people behind their mortgages, giving them time to catch up before the bank can foreclose on the property.

There are limits to the amount of debt that can be managed through this kind of bankruptcy, and anyone wishing to enter into the process must be up-to-date with their tax filings.

The Limitations of Bankruptcy

Bankruptcy is a major decision, and it is recorded on your credit file. A Chapter 7 bankruptcy stays on your credit file for ten years, and if you have been bankrupt in this way, you can’t file again for eight years. A Chapter 13 bankruptcy stays on your credit report for seven years, and you have to wait two years between filings.

Strategies for a Healthy Financial Life

Before you make any major financial decisions, such as pursuing a settlement plan or entering into a bankruptcy arrangement, it’s a good idea to seek advice from an expert. Organizations such as Debt.org offer free advice and support for people who are overwhelmed by their finances, and there may be local charities that can assist you too.

Another option is to look for free courses at your local community college. Many now offer financial literacy courses that can make navigating the world of personal finance less stressful.

Once you have your financial life under control, you’ll want to keep it that way. Whether your debts were caused by an unfortunate change of circumstances or simply living beyond your means, you can do some simple things to reduce the likelihood of it happening again.

Build an Emergency Fund

Try to put some money aside each week to build an emergency fund. It all mounts up even if all you can save is a dollar or two. Once you’re debt free, increase the amount you save. Ideally, your long-term goal is to have at least one month of income saved in an account that you can access quickly. Some people aim for three or even six months.

Any savings you have beyond that can go into investments, giving those funds a chance to appreciate in value through interest or dividend payments.

At this stage in your financial journey, the idea of having a large emergency fund may seem a long way off, but the sooner you start building it, the better a position you’ll be in should you experience an unexpected expense or loss of earnings.

Establishing Good Financial Habits

After living with financial uncertainty for a long time, it can be hard to form good financial habits. Start small by setting up regular transfers to your emergency fund and automating bill payments so you don’t get hit with late payment fees.

Get used to shopping around and look at bulk purchase discounts or things like purchasing an annual subscription instead of a monthly one for items that you use regularly. Look for a bank account that allows you to set up “pots” or separate accounts for savings and expenses so you can ring-fence funds and not spend them accidentally. Transfer over money each month to cover larger expenses so you don’t struggle when tax season comes around or it’s time to renew your insurance policies.

These small habits will save you money in the long run and help you avoid overspending.

Avoiding Unnecessary Debt

If you’ve been in debt, used a settlement company, or declared bankruptcy, you won’t be able to access traditional lenders for a little while. Consider this a blessing because it will give you time to form good financial habits.

If you cleared your debts before they reached that stage, you might have come away with a clean credit file. It’s important to avoid running up new debts, especially in the first couple of years after you beat your financial issues. When you’re considering borrowing money, ask yourself whether it’s worth it. Will you be glad you took out that loan in a year when you’re still paying for whatever you want to buy? If the answer is no, don’t take out that loan.

Planning For the Future

Borrowing money is, essentially, borrowing time from your future self because you’ll have to work more hours to pay for whatever you borrowed. Saving is giving a gift to your future self. Hopefully, one that will be worth more to them than it is to you right now.

Once you’re debt free, re-evaluate your budget and put a portion of the money you used to clear your debts into a retirement account. You’ll be glad you did.

It is Possible to Become Debt Free

Facing up to having significant debts can be intimidating, and when you first work out how long it will take to pay off those debts, you may feel the problem is insurmountable. Remember that many people have walked this path before you and successfully found their way out of debt.

There are many options for becoming debt free, depending on your income and the level and type of debt you have. If you have sufficient income to service your debts, creating a budget and focusing on paying off those debts in a way that motivates you and minimizes the interest paid is likely the best option. For those who can no longer service their debts due to changing circumstances, negotiating with creditors or looking at a debt management plan is the next logical step.

Bankruptcy is the last resort for those who truly need to wipe the slate clean, and it can be an invaluable way of getting a fresh start. If you learn from the events leading up to the bankruptcy, you’ll be well-positioned to start a new life with healthier finances.

AtSave Plan Retire, we offer a wealth of information about financial literacy to help people at different stages of their lives take control of their finances. From building up that first emergency fund to growing a nest egg for retirement, we can help you understand your options and make plans to manage your money better.

The first step to a financially stable future is to get out of debt, and by reading this ebook, you’ve already started that journey. Take advantage of the resources we’ve mentioned. We hope you stay motivated as you watch your debts slowly trickle down, and we wish you the best of luck in the future.