Even for small amounts of debt, you’ll need to earn over six-figures in income to pay it off.
If that sounds preposterous, you only need to do the math. If you’re sticking to a reasonable repayment schedule that makes a dent in your debt without wrecking your life, six-figures of income is required to pay off five-figures of debt.
Of course, when I say this, I don’t mean you need to earn six-figures in one year (unless you plan to pay off your debt in one year!). Instead, the total is the sum of the income you earn in the years you pay off your debt. The longer it takes you to pay off your debt, the more you’ll need to earn over time in order to do so.
Exactly how much of your income should be going towards debt repayment?
As a general rule of thumb, 15% of your net income should be going towards repaying debt. This is usually enough to go beyond the minimum payment required and really start reducing your principal. It’s also enough to leave 85% of the rest of your income for other expenses!
If your minimum payments consume more than 15% of your income, you’re probably feeling very constrained. Other areas of your budget will suffer as you try to tackle your debt. You’ll have to find a way to reduce the cost of your debt, or increase your income.
If you’re not putting at least 15% of your income towards your debt, chances are you are not really feeling a significant motivation to pay it off. Let this article be the motivation you need!
Of course, there’s nothing stopping you from putting more than 15% of your income towards your debt. If you can, you definitely should!
The real cost of $25,000 of debt is over $200,000
As an example, let’s say you borrowed $25,000 for school. How many years are you stuck with that debt? Well, it depends on how many years it will take you to gross a couple hundred thousand dollars.
If you’re paying 15% of your income towards debt, you’ll need to earn more than $165,000 to pay it off (and that’s not even including interest). This can take 3 to 5 years or more depending on your income.
$25,000 /15% = $166,667
Note that the above is net income. If your income tax rate is 20%, you’ll actually need to gross over $200,000 to totally vanquish your debt.
$166,667 / 80% take-home pay = $208,333
If your tax rate is higher, you’ll need to earn even more!
Bet you never thought of your $25,000 debt balance as a $200,000+ beast, but it is. In fact, you should estimate most of your debt balances to cost you 10x in income to pay off. After income taxes and interest costs, that’s what you’re really looking at.
You need to earn 10x your debt balance in order to pay it off
The above calculations account for income taxes, but not interest. Since interest rates on debts can vary from 1% to over 30%, it’s tough to make a sweeping estimation of how much your debt will actually cost you. But a good rule of thumb is to assume that if you’re following the 15% rule, you’ll need to earn 10x your debt balance in order to pay it off.
Yes, 10x. That means your $25,000 debt will probably mean you’ll need to gross a cool $250,000 if you’re paying it off at the rate of 15% of your net income.
The more debt you have, the more you’ll have to earn to take care of it. Yes, it’s depressing, but maybe it can also be motivational. You have a few options to vanquish the balance sooner rather than later.
How to pay off debt super fast
Getting out of debt is hard work, but there are a few things you can do to make the debt repayment process easier. Focus both on reducing the overall carrying cost of your debt, as well as shortening the repayment timeline.
Consolidate your debts at a lower interest rate
If you can reduce the interest rate on the balance you owe, you will reduce the carrying cost of your debt.
If you have a good credit score, you might qualify for a better interest rate than you’re currently getting. I’ve always been careful to pay bills on time and hold different kinds of credit (regular bills/contracts, student loans, credit cards, line of credit) to keep an excellent credit score to ensure I get the lowest rate. You can check your credit score and even look for consolidation loans with Borrowell.
Speak to your bank or credit union about taking out a low-interest line of credit andusing it to pay off any high-interest debt. Unsure if this is for you? Check out our post Should You Use a Line of Credit to Pay Off High Interest Debt.
Increase the frequency of your payments
Paying $50 bi-weekly will save you more interest than $100 once per month. You can even be so bold as to try out daily transfers to your debt, so you never accumulate the daily interest charge! Sound wild? There’s a whole post on this simple debt hack here.
Increase the amount of each payment
This is both the most difficult and most effective step. Increasing your payments will make your loan go away faster and reduce the overall amount you pay. This is my least favorite step since it means removing cash from my disposable income, but until you’re debt-free, your money isn’t really yours anyway.
Snowflake extra micro-payments towards your debt
While most of the suggestions above work on your regular debt repayment schedule, there’s nothing stopping you from throwing extra dollars at your balance owing when you can. It might feel silly to transfer $5 to your debt, but even small amounts can make a difference.
Debt “snowflakes” are small amounts of found money that you throw at your debt. It can be anything from a few extra dollars to a full extra payment. These are off your regular repayment schedule, so they reduce the principal so your regular payments go even further.
No matter what you choose, getting out of debt is rarely a good time. But it’s better than staying in debt forever! So do what you can now so you don’t have to earn more later.