How to Pay Off Debt Quickly (with Low Income)

Embark on a journey to financial freedom! Debunk the myth that a tight budget on low income hinders debt payoff. Discover practical strategies covering how to pay off debt quickly with low income. Ready to take control of your debt? Read on for actionable steps!

Debt is defined as an agreed amount of money borrowed by one party (the borrower) from another party (the lender). Companies and individuals often borrow money to purchase an item of relatively high value that they could not have purchased without help. The borrower then pays off the debt over a specified timeframe to cover the cost of the loan. The borrower usually needs to pay interest, which is a percentage of the borrowed amount. This interest covers inflation and lender profits. Keep reading to learn how to pay off debt quickly with low income.

The different types of debt

Debts can be between individuals, between an individual and a company, between companies, between companies and governments and between governments. The debt covered in this article focuses on debt between an individual and a company such as a bank.

The two most common types of debt are:

• Loans such as home loans (mortgages), business loans, and car loans. These are fixed value loans that have regular repayments and a term, or due date.
• Credit such as credit cards and retail cards. Purchasing an item on credit results in the debt being variable. Repayment is usually based on a minimum amount per month and therefore there is no fixed due date.

Debt can be thought of as using tomorrow’s money to pay for today’s lifestyle. An important part of budgeting is learning how to identify whether a debt is good or bad. Budgets can help you manage your good and bad debts to pay them off effectively and quickly.

Good debt

Debt used to purchase an asset that increases in value over time or increases cash flow is termed “good debt”. Interest rates for these types of debts are comparatively low. An example of good debt is a home mortgage. A student loan is good debt if it results in achieving a higher paying job that helps to increase income. Likewise, a business loan is good debt if it helps the business increase revenue. Consider the following simplified, hypothetical example.

Good debt example: A couple purchased a house 30 years ago valued at $145,000 with a deposit, or downpayment, of $30,000. Fees and other costs associated with the purchase amounted to $5,000. Their initial debt was $145,000 + $5,000 – $30,000 = $120,000. They had a contract with their bank to pay the mortgage with a term of 30 years at an interest rate of 4.0%. The value of their property increased to $700,000 by the end of the 30-year term. Their house has increased in value by $550,000, or by an average of nearly 5.3% per year. Factoring the interest payments of about $86,200* over the term of the loan, the effective increase in their net worth from this house is $550,000 – $86,200 = $463,800.

Good debt can become bad debt if the money isn’t managed effectively. It should go without saying that all debt comes with some level of risk. Preventing or minimising risks (such as taking out car and home insurance) can help prevent good debt from becoming bad debt.

Bad debt

Debt used to pay for something that decreases in value over time or decreases cash flow is termed “bad debt”. Interest rates for bad debts are comparatively higher than for good debts. Credit card and retail card debts, if not paid off in a specified time period, are examples of bad debt. The use of credit cards isn’t necessarily bad providing the monthly payments are made in full. In that case, you are not paying high interest on the amount owed (often over 15% per year). If you struggle to pay down this type of debt, you’d be better off using a debit card instead of a credit card. Debit cards are linked to a transaction account that draws on your own money to pay for goods and services. There are no annual fees or interest payments incurred from using debit cards.

Personal loans are another example of bad debt because they are often used to purchase items that decrease in value. Car loans are considered bad debt unless the vehicle is necessary for business purposes that consequently helps to increase cash flow.

Some of the worst types of debt are payday loans, also called salary loans, short term loans, or cash advance loans. These incur the highest interest rates because they are short term and unsecured. They must be paid back with interest by the borrower’s next pay, or within an agreed time period. The borrower incurs extra fees and increased interest if the loan is not paid back in full and on time. Due to the nature of these loan types, most countries have introduced legislation to reduce the negative impact on the borrower, including placing an upper limit on interest rates and fees by the lender.

Bad debt example: A young lady owned an old car that was unreliable, and she was desperate to sell it and buy a more reliable second-hand car. She sold her car for $1,000 and found a second-hand car in reasonable condition for $5,500. She needed a $4,500 loan to purchase the car.

After visiting an online payday loan website that advertised “instant” loans up to $5,000, she applied for a loan and bought the car. Her next pay arrived and she noticed a direct debit from her account of the loan amount, plus interest of $300. The interest was equivalent to a rate of 80% per year! She paid $4,800 in total for a car that she purchased for $4,500.

As she had little disposable income, she needed to forego some food and other necessities to pay off other debts. If she had utility bills to pay that month or an unexpected financial emergency, she would have struggled even more.

Buy now, pay later services

Buy now pay later providers such as Afterpay, Zip, and Latitude Pay offer interest-free payment options for purchasing items. They are a convenient way of spreading the payment of an item into smaller amounts over a period of time while allowing the item to be taken at the time of purchase.

In addition, no interest is charged for the purchase. These providers make money by charging the retailers, who can attract more sales through the buy now pay later model, a per-transaction fee for their service. Some also charge members a monthly fee for the use of their service.

Are they a form of debt? Yes. They are similar in concept to buying a house or car with a loan. You take ownership of a product and pay it off over time, but with zero interest. You are indebted to the provider until the item is fully paid for.

Payments are usually automated via direct debit from the buyer’s bank account. No extra payment is required if each direct debit transaction is successful. In this case, the product has been purchased at the sale price (ignoring the monthly fee, if charged).

However, if a scheduled direct debit payment is unsuccessful due to insufficient funds, penalty fees are charged. Penalty fees vary between providers and are based on the cost of the item and/or the amount owing.

When using these buy now, pay later services, it is important to research the fee structures and options before signing up with a provider. It is also important to ensure sufficient funds are available in the nominated account to prevent penalty fees from being charged. Having a budget will help determine whether sufficient funds are available for these additional regular payments.

How to pay off debt quickly and effectively, even if your income is low

To manage debts effectively, including how to pay off debt quickly, follow these steps:

Determine why you have debt in the first place

This is especially important for credit card debt and other bad high-interest debts. Are you an impulse buyer? Do you buy items that you don’t really need, but you like to impress others? Try and find the root cause of why you have bad debt so that you can be more aware of and avoid, or at least reduce, bad debts in the future.

Identify ways to pay off the debt

Never add more bad debt to your existing bad debt pile. Doing so will make matters worse, and can result in your debts spiralling out of control.

Managing a single debt is relatively simple in theory. The aim is to pay the minimum amount at the beginning. Then reduce spending to pay off the debt sooner with the additional cash remaining at the end of the month. This has the added bonus of reducing the amount of interest you need to pay.

Warning: Beware of loan contracts that result in extra fees being charged if more than the minimum payments are made. Check with your bank or broker first to ensure you don’t end up paying more than expected.

How to pay off multiple debts

Managing multiple debts can be a little more complex, and involves listing all of your debts and categorizing them into good or bad debts. Determine whether a debt is considered good or bad based on the definitions above.

List each debt and include who the debt is owed to (the lender), the term (how long it will take to pay off if applicable), the current interest rate and how much is owing on the debt.

More bad debts require more extreme measures to pay them off. Keep discretionary spending to an absolute minimum to pay off multiple bad debts as quickly as possible. Reduce or eliminate savings for other purposes until the bad debts have been eliminated.

There are a number of effective strategies for paying multiple debts off quickly. The decision on which strategy to go with is based on personal preference. There is no right or wrong choice – what’s more important is paying off the bad debts first. Some common debt reduction strategies are described below.

Debt consolidation

One of the most cost-effective ways of managing multiple debts is debt consolidation.

This strategy will reduce the cost of fees resulting from paying off a number of separate debts. It may also reduce the total amount of interest paid.

Focus on consolidating higher interest rate debts such as payday loans (if feasible), credit card and retail debts into a lower interest rate debt consolidation loan for example.

If you have a mortgage you may be able to draw on the equity of your home to pay off the higher interest rate debts and personal loans. Talk to your bank or mortgage broker to determine the most cost-effective option available to you.

Lowest value loans: the snowball method

With this method, order your debts from the lowest value (dollar amount) to the highest value. The interest rates are not considered when listing them.

Pay more into the lowest value loans first whilst paying the minimum amounts on the remaining loans. This method, known as the snowball method, results in paying off smaller debts first to boost confidence.

Paying off debts in small steps may not be the best in terms of cost-effectiveness when compared to some of the other methods., but each debt paid off is like a small psychological win. The boost in confidence will make it easier to focus on the next biggest debt and pay it off, and so forth.

High interest loans: the avalanche method

With this method, order your debts from the highest interest rate to the lowest interest rate. The dollar amounts of each debt are not considered when listing them.

Pay more into the highest interest rate loans first whilst paying the minimum amounts on the remaining loans. This method, known as the avalanche method, is a cost-effective way of paying off multiple debts. It eliminates the bad debts first, helping to reduce the total interest paid on the bad debts.

Highest emotional impact

Pay more into the highest emotional impact debt whilst paying the minimum amounts on the remaining loans. For instance, you may feel obliged to pay a family member or friend off first in order to maintain a good relationship.

This strategy may not be the most cost-effective, but it can reduce stress, boost confidence, and allow you to keep a family member happy or maintain a pleasant friendship.

There can be times where a single strategy isn’t suitable. Alternate between the different strategies if necessary. Whichever strategy you choose, the aims are to reduce bad debt first to increase cash flow. It is still important to pay at least the minimum payment on all debts to avoid late payment fees and a bad credit score.

As a consequence of reducing debt, you will learn how to identify, minimise and handle bad debt in the future. Creating and adhering to a budget is a useful method for analysing cash flows and debts, and for determining effective ways to pay off debt quickly. Budgets also help identify and prevent bad debt decisions from being made in the first place.

General rules of thumb for keeping debt under control

Managing debt effectively and keeping it under control can be summarized in a few general rules of thumb, which include:

• Avoid credit card debt. You can use a credit card, but make sure you pay the credit in full each month to prevent interest payments. If you don’t have the discipline or ability to pay off the balance in full each month, don’t use a credit card.
• Prioritise paying off debt on loans with higher interest rates as much as possible. The avalanche method mentioned above is one of the more effective ways of paying off debts. By the time you are in your 50s and approaching retirement, you should have minimal debts. Avoid life choices that result in the need to pay off debt after retirement.
• Keep household expenditure below about 25% of your gross (pre-tax) income.
• Keep monthly car loan payments below the amount you set aside for savings each month. Pay yourself more than the bank. In addition, keep the loan term no more than 3 years. If you can’t afford to pay a car loan with these conditions, look at buying a cheaper, more affordable car.

Are there other methods that you use to pay off debt? Leave a comment below!

More resources on managing and paying off debt

The following books provide more detailed information on the topics covered in this article. Feel free to browse through this list and support the site by making a purchase at one of our affiliate partners. Please read our affiliate links disclosure for more information. Note: The links below will open in a new browser tab or window.

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• The Spender’s Guide to Debt-Free Living: How a Spending Fast Helped Me Get from Broke to Badass in Record Time by Anna Newell Jones Link*
• How to Be Debt Free: A simple plan for paying off debt: car loans, student loan repayment, credit card debt, mortgages and more by Avery Breyer Link*
• Featured books on managing debt Link*

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