Using a budget to pay off debt is a sensible option that can help you reach your goals effectively.
A budget can help you focus on eliminating debt and ensure you address other important financial priorities. It can give you a plan for putting money into emergency savings and allow you to reward yourself as you make progress.
Here's a simple guide on how to make and use a budget to get out of debt.
How to create a budget to get out of debt
If you are in debt, you will likely have to change your spending habits to get out of it. However, this doesn’t mean that you have to cut out every single expense and get by on the bare minimum.
You can take a few different approaches to budgeting. Here are two of the most simple:
Classic budgeting strategy:
With a classic strategy, you would subtract your expenses from your income; this will show you how much money you have left at the end of each month. If you have money spare, you can use it to pay off debts each month.
If you don’t have any money left over, it’s time to take a look at your expenses. Cutting out any unnecessary spending and focusing more on ‘needs’ than ‘wants’ should help you find extra space in your budget.
To undertake this approach, you need to know exactly how much you make each month and how much you usually spend. Remember to consider rent/mortgage payments, utility bills, and food shopping.
This is a good way of getting to know your finances, which will help you have a clearer view of how to become debt-free.
The 50/30/20 rule:
The 50/30/20 rule is a strategy that helps you to categorise your spending, allowing you to clearly budget your expenses each month.
The idea is that 50% of your monthly income, after tax, is used on ‘needs’. This will include mortgage/rent payments, utility bills, food, and transportation.
30% is spent on ‘wants’, so things like new clothes, meals out, and entertainment. This category can be reduced if you want to save more money or focus on clearing debt.
The final 20% should be saved or used to clear debts. If you can allocate more money to this section, you will pay off your debts faster.
This strategy is useful for people who need a clear-cut budget, as it allows for a specific amount of spending per month.
The benefits of creating a budget to get out of debt
- Budgeting helps you understand your finances. You will become more familiar with your spending habits, which will show you how you can cut back to focus on paying down debts.
- By building a budget, you will allocate money towards non-essential items. This means that you can still enjoy treats, and you are less likely to lose motivation.
- Once you have paid off your debts, you’ll be in a much better financial situation to start focusing on other goals. You could use the strategy you’ve employed to start building your savings or an emergency fund.
Alternative ways to pay off debt
Budgeting isn’t the only way that you can pay off debts. Here are some other options:
- Debt consolidation: A debt consolidation loan is used to combine multiple debts into a single monthly payment. This helps simplify and streamline your finances. However, some of these loans may be secured against your property, so if you don’t keep up with the repayments, you could risk having your home repossessed.
- Debt avalanche method: The debt avalanche method prioritises paying off your highest-interest debt first. After clearing one debt, you apply that payment amount to the next highest debt, continuing this process until you've paid off all your debts.
- Debt snowball strategy: The debt snowball method involves prioritising the smallest debts first. After paying off the smallest one, you take the amount you were paying and add it to the next smallest amount. This process continues until all debts have been paid off.
You can use a budget to get out of debt while employing these strategies. This combination may provide you with a clearer understanding of your finances and potentially speed up the process of paying down your debts.
Summary
Adopting a budget can be an important step toward paying off debt effectively. Employing a budgeting strategy will help provide a clear roadmap for managing income, expenses, and savings.
Creating a budget to pay off debt isn’t the only way. There are alternative methods, including debt consolidation and the debt snowball and avalanche methods. These plans could be used in conjunction with a budget to help speed up the repayment process.
If you're struggling to manage your debt, speak with your lender quickly to explore possible support. You can do this directly or through a debt charity. If you need more information and free advice, contact: MoneyHelper or Citizens Advice Bureau (CAB).
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a mortgage or any other debt secured on it.
