If you have credit card debt, your immediate financial goal should be to pay off that debt as quickly and efficiently as possible. To get you started, I’ll show you exactly how to make a budget to pay off debt.
On your journey to financial freedom, getting rid of credit debt is crucial.
It is nearly impossible to get ahead financially if you are paying 20% interest or more on credit card debt. That type of drag on your money is just too strong.
Think about it: the stock market has historically averaged a 10% annual rate of return.
Does it make any sense to prioritize investing in the stock market to earn 10% per year if, at the same time, you are paying 20% in interest on your credit card debt?
Each year you follow this pattern, you are losing more and more money.
So, the first thing you should do is come up with a plan to pay off your credit card debt. Once the debt is gone, use that money for investments.
Today, we’ll look at how to make a budget to pay off debt so you can begin fueling your investments.
If you can follow these three steps, you’ll have a budgeting framework in place that will serve you well, long after you’re out of debt.
Paying off debt is the hard part. If you can do it, you’ll soon realize that it is a lot more fun to see your money grow each month instead of only seeing your debt shrink.
Let’s dive in.
Making a budget to pay off debt is about having a plan ahead of time.
The art of budgeting is to know what you want to do with your money before it hits your checking account.
Otherwise, it’s too late. Those dollars will disappear.
In fact, the word “budget” is synonymous with “plan”.
How do you come up with a plan, or budget, to pay off debt?
I teach my students that to create a budget to pay off debt, you need to first study your own personal situation to figure out where your dollars are currently going.
Then, you can figure out a plan for how to use your next dollar before you earn it. This applies not just to bonuses or other unexpected dollars, it applies to every dollar you earn.
When you put the time in to study your own habits, you can then create a realistic budget. When you have a realistic budget, you will have confidence that your dollars are working for you.
Some dollars will be used to pay your ordinary life expenses, some dollars will be used for all the things in life you love, and some dollars will go to your financial goals, like paying off debt.
That’s all there is to it.
If you don’t currently maintain a budget, here are three steps to follow to get you started.
Step 1: Track your spending for at least 3 months.
I recommend everyone, regardless of where you are in life, start with this first step of tracking your spending for at least three months.
Without knowing where your money is currently going, you won’t be able to make adjustments so you can pay off debt faster.
In other words, before you can reduce your debt, you have to make sure your debt is not growing each month.
That means not spending more than you can afford to pay off each month.
While that may seem obvious, many of us have trouble living within our means.
That’s a problem if you’re hoping to make a budget to pay off debt.
To address that problem, you need to track every penny for at least three months. Then, you’ll know exactly how much you’re spending and can begin to think about areas of improvement.
So, before you go any further in the budgeting process, you need to commit yourself to tracking every penny for three months and only charging what you can afford to pay off.
Fair warning, you probably won’t enjoy this part of the budgeting process.
Tracking your spending is important even if it’s not enjoyable.
I won’t lie to you.
This step can be hard and you probably won’t like it. This is the step that makes people think budgeting is a nasty word.
I get it and don’t blame you for having that reaction.
Still, there’s no getting around this first step. You don’t have to budget forever, just long enough to learn your own behaviors towards money.
Please know that many of us struggle with this first step. You might not like what you learn by tracking your spending.
When I first started budgeting, I learned that I was $20,000.00 in debt and was spending way more than I earned.
That wasn’t fun, but I’m happy that I put in the effort to find my blindspots and make adjustments.
I often think to myself, “Where would I be today if I didn’t go through this process 15 years ago? How much further into debt would I have fallen?”
Talk to your people as you make a budget to pay off debt.
One last thing, budgeting is one of those areas where it can really help to talk with our people along the way for support and encouragement.
You don’t have to budget in secret. We’re all in this together.
Put the mental energy into this step, so you can stop wasting mental energy worrying about debt and start getting energized thinking about money.
The good news is, tracking your spending is easier today than it’s ever been. I’ve used apps, spreadsheets, and even the notes function on my phone.
Regardless of how you track your spending, be honest with yourself. If you intentionally or mistakenly leave out certain expenditures, you won’t learn where your money is actually going.
A budget, which is just a plan, is only as good as the data it’s built off of. Be honest about your data.
Last note: Budgets are usually done monthly, so you’ll want to create a separate accounting for each month you tracked.
The reason we track three months of spending is so you’ll be able to identify any patterns or inconsistencies in your spending from month-to-month.
This helps ensure you’re making decisions based off the best data possible.
Step 2: Separate your spending into three three main categories.
Great work completing the first step! That wasn’t easy, but you did it.
Now that you have tracked your spending for three months, you can assign each expense into separate categories.
Most personal finance experts agree, though we have different names for each category, that you should divide your money into three main buckets.
I refer to these buckets as:
- Now Money
- Life Money
- Later Money
1. Now Money
Now Money is what you need to pay for basic life expenses.
These expenses include housing, transportation, groceries, utilities (like internet and electricity), household goods (like toilet paper), and insurance.
These are expenses that you can’t avoid and should be relatively fixed each month.
If you’re making a budget to pay off debt, it’s going to be hard to cut from this category, unless you are willing to make major changes. That means moving to a less expensive home or giving up your car, which are not always feasible.
That said, if you are in the position to make these kinds of big changes resulting in serious savings, you can accelerate your path towards being debt-free.
2. Life Money
Life Money is what you are going to spend every month on things and experiences in life that you love.
This bucket includes dining out, concerts, vacations, subscriptions, gifts, and anything else that brings you joy.
We can’t be afraid to spend this money. This bucket is usually what makes life fun and exciting.
The key is to think and talk so you are spending this money consistently on things that matter to you.
If you are truly dedicated to paying off debt, this is the major category to focus on. If it costs $100 to go out to eat, and $10 to eat dinner at home, that’s $90 that could potentially go towards paying off debt.
When you repeat that decision over and over, you can aggressively attack your debt.
3. Later Money
Later Money is what you are saving, investing, or using to pay off debt.
This bucket includes long term goals, such as retirement plan contributions (like a 401k or Roth IRA), college savings for your kids (like a 529 plan), emergency savings and paying off student loan or credit card debt.
This bucket also includes any shorter term goals, like saving for a wedding or a downpayment for a house.
Most fun of all, this bucket includes any investments you make to more quickly grow your wealth, like investing in real estate or the stock market.
You’ve probably guessed it already. Later Money is the key category that fuels your ultimate life goals, like financial independence.
The more you fuel this category, the faster you can reach your goals.
When your goal is to pay off credit card debt, any fuel you generate in this bucket should go to paying off that debt.
With the exception of contributing enough to receive your company’s 401(k) match and creating a small emergency savings account, all excess money should go towards paying off your credit card debt.
Don’t worry about assigning a percentage to each category.
I have intentionally not recommended target amounts or percentages to allocate to each of your three categories.
The reason is because of what I’ve learned from my students over the years. I’ll lay out my full reasoning in a separate post.
The short version is that in my experience working with law students, assigning target percentages for each category is counterproductive.
When I used to teach my students to aim for certain percentages in each category, I could tell that they would get discouraged as soon as I put the numbers on the slideshow. I completely understand why.
Each of us is starting in a different place. If you are currently spending 80% of your monthly income on Now Money, it’s not helpful to have someone tell you to create a budget that automatically drops that level to 50%.
My students would tune me out as soon as I put those numbers on the board.
Now, I teach my students to think and talk about their current personal realities and aim for steady and lasting improvements.
I want my students to create a plan that will last, not an unrealistic plan that they give up on after a few months.
So, whatever amount you’re currently spending in each bucket, that’s what we’re going to work with as we move on to step 3.
One other thing before you move on to step 3: don’t get hung up stressing about what type of expense goes into each category.
Sometimes, it gets tricky. Do clothes you buy for work count as Now Money or Life Money?
Don’t stress. It doesn’t really matter. It’s not worth the mental energy thinking about it. Just stay consistent and move on.
If you still want a target, aim for 20% of your income added to your Later Money each month.
All that said, I know that some of us operate better if we have a specific target in mind. If that’s you, the conventional wisdom is to aim for 20% of your income added to your Later Money each month.
Obviously, the more you add to Later Money, the faster you will pay off your debt. So, if you can afford more than 20% toward credit card debt each month, do it.
If you’re curious, targeting 20% savings each month was popularized in Elizabeth Warren’s book, All Your Worth: The Ultimate Lifetime Money Plan, first published in 2005 (before she was Senator Warren, she was a law professor and author).
Senator Warren advocated for a 50-30-20 budget framework with 50% going to fixed costs (what I call “Now Money”), 30% going to wants (“Life Money”), and 20% going to financial goals (“Later Money”).
Most personal finance experts agree that the 50-30-20 framework is a solid plan for your budget.
In theory, I agree.
In reality, I’ve become convinced through working with my law students that the 50-30-20 framework does not cut it in today’s environment.
Some experts have even suggested that a 60-30-10 framework may be more appropriate today.
While I agree the 60-30-10 framework may be more realistic, my experience has taught me that assigning rigid percentages is just not a practical framework for most people at the beginning of budgeting process.
Step 3: Make adjustments so your spending better aligns with your true motivations and desires in life.
OK, so now that you have assigned your spending to each of the three categories, the next step is to think and talk about your current habits and whether you’re spending matches your true motivations and desires in life.
If you decide that your spending does not match your life values, then it’s time to make some adjustments.
When you’re in credit card debt, the goal of these adjustments is to create more money each month to pay off your debt.
What kind of adjustments can you target?
In essence, my budgeting philosophy is to aim for steady and lasting improvements based on your current reality and your ultimate motivations.
What does that mean?
This is where we circle back to the importance of having a clear understanding of what we want out of our money. Money is just a tool.
Ask yourself:
“Is your current spending aligned with how you want to use your money to fuel your goals and ambitions?”
If not, you can make incremental adjustments as you progress towards your ideal spending alignment.
The idea will be to continuously add more fuel to your Later Money bucket so you can eliminate your debt faster.
You can make small adjustments, which are usually easier and faster to put in place. These adjustments might include dining out a bit less, cutting out a concert, or cancelling a gym membership or subscription you don’t use.
You can also make big adjustments, like moving to a cheaper part of town or getting rid of you car.
Small or big, the key is that when you make these adjustments, you repurpose that money in a thoughtful and intentional way. When you’re in debt, that means repurposing those savings to paying off debt.
Once your debt is paid off, you can put those savings towards your other financial goals.
You’ve already done the hard part. You’ve already aligned your budget with your money motivations.
With each thoughtful decision, you’re progressing towards your best money life. Most importantly, you’re learning about yourself and developing lasting habits. You won’t get discouraged and give up on budgeting.
To help you better understand how to make a budget to pay off debt, here is exactly how I did it when I was in debt in my twenties.
Here’s an example of how to make a budget to pay off debt.
In today’s budgeting example, we’ll look at how I made a budget to pay off debt in my twenties.
The dollar amounts below are what my actual income and spending looked like back then, adjusted for today’s dollars and rounded for easier math.
For some context, I was 26-years-old, living by myself in Chicago (no dependents, no pets), and working as a “slasher.” Not a joke, that was my actual job title.
I worked for a judge with the Appellate Court of Illinois, and as the junior member of the team, my responsibilities included lawyer duties and secretarial duties. I was a judicial law clerk “slash” secretary. Hence, slasher.
Lawyers are funny, huh?
In today’s dollars, I earned an annual salary of $90,000.00. That means I earned $7,500.00 per month. We did not have bonuses at the courthouse, so the $90,000.00 salary was my full compensation.
The benefit of going through an example like this is not to compare your situation to mine. Your income might be much higher or much lower. Same with your expenses.
Instead of the numbers, focus on the thought process so you can start to think about adjustments that suit your current life to help you pay off debt.
Below, you’ll see charts showing that I completed each of our three steps to make a budget to pay off debt:
- Step 1: I tracked my spending for 3 months and reflected the average monthly amount for each expenditure in the column labeled “Baseline Budget.”
- Step 2: I created a separate chart for each of the three main categories: Now Money, Life Money, and Later Money.
- Step 3: I made thoughtful adjustments to better align my spending with my true motivations in life. I illustrated my decisions in the third column labeled “Budget After Thinking.”
Now Money
Recall that Now Money is what you need to pay for basic life expenses.
These are expenses that you can’t avoid and should be relatively fixed each month. If you have expenses for kids, pets, and other fixed life expenses, be sure to include them in your Now Money category.
| Now Money | Baseline Budget | Budget After Thinking |
|---|---|---|
| Apartment rent | $2,200 | $2,200 |
| Renter’s Insurance | $20 | $20 |
| Parking spot | $430 | $0 |
| Gas for car | $40 | $40 |
| Car Insurance | $50 | $30 |
| Car Maintenance | $150 | $150 |
| Utilities | $120 | $120 |
| Internet | $60 | $30 |
| Cell Phone | $55 | $35 |
| Groceries | $300 | $240 |
| Personal upkeep(wardrobe, haircuts, etc.) | $100 | $75 |
| Gym Membership | $360 | $360 |
| Budget Busters | $300 | $300 |
| Now Money Total | $4,185 | $3,600 |
What I learned tracking Now Money.
Now Money is pretty easy to track. There is not a whole lot of variance from month to month.
You’ll notice immediately that I had one major expenditure that needed immediate adjustment. That parking spot for $430? Definitely did not need that.
I lived 2 miles from work in one of the best cities for public transportation in the country. It was frustrating at times to look for street parking, but I didn’t use my car enough to justify the cost of a parking spot.
The other adjustments resulted in more minor savings, but don’t ignore these. Each adjustment took relatively no effort to make, just a little bit of thought beforehand.
When I say relatively no effort, I mean three phone calls and three reductions for car insurance, internet, and cell phone. That’s $70 saved per month, or $840 saved per year, for about 30 minutes of effort.
Otherwise, I decided to show a bit more restraint when grocery shopping and found a cheaper place to get my haircut.
All told, I reduced my Now Money Budget After Thinking by $585 per month with a little bit of thought and hardly any effort.
That meant $7,020 per year I could reallocate to paying off debt.
Life Money
This bucket, Life Money, is what you spend every month on things and experiences in life that you love.
| Life Money | Baseline Budget | Budget After Thinking |
|---|---|---|
| Social Life (dining out, concerts, ball games, etc.) | $800 | $700 |
| Purchases (books, fun clothes, gifts, etc.) | $200 | $150 |
| Travel | $500/mo ($6,000/yr) | $400 |
| Cubs Season Tickets | $400/mo ($4,800/yr) | $400 |
| Budget Busters | $200 | $200 |
| Life Money Total | $2,100 | $1,850 |
What I learned tracking Life Money.
When you’re reviewing your Life Money expenses, don’t be overly aggressive in cutting here. These are the things and experiences that make your life enjoyable. Even modest adjustments can make a big difference in the long run.
For tips on adjusting your Life Money without sacrificing the things and experiences you love, check out my post here.
As we saw with Now Money, with some thought and very little effort, I reduced my Life Money Budget After Thinking by $250 per month.
That meant another $3,000 I could use to pay off debt.
Some bonus tips for tracking Life Money
Life Money is the most annoying category to accurately track. These expenses vary month-to-month. You may buy concert tickets or have a trip planned some months, but not every month.
So, how do we get an accurate picture of our Life Money?
This is why I recommend you track your spending for at least three months.
You’ll get a more accurate picture because you can average your Life Money spending over those 3 months and balance out any inconsistencies.
Of course, if you have the patience to track your spending for even longer, you’ll get an even more accurate picture.
Fortunately, it is easier to track our spending today with the availability of apps and online banking platforms that can automatically track your spending.
Keep it simple when tracking your Life Money.
I highly recommend you keep it simple when tracking your Life Money. Many of my students give up on budgeting because they make this category more complicated than it needs to be.
I really struggled with this at first because I was so concerned about doing it right.
What I learned was that it doesn’t matter. If you go to happy hour with friends, don’t agonize over whether that goes into your “Dining Out” category or your “Drinks” category?
It doesn’t matter. Make it easy on yourself. Have one category called “Social Life” and move on.
Don’t forget that the point of budgeting is to learn your current habits so that you can make thoughtful adjustments.
Don’t let yourself become so obsessed with the details that you get stressed and give up on budgeting.
Break down large, annual expenses on a monthly basis.
One last tip, when you have large expenses, like season tickets or a big vacation, it’s helpful to break down those expenses on a monthly basis.
That way, you can see how much those individual purchases are impacting your overall monthly goals.
I’m not suggesting you actually pay for that trip over 12 months (like on a credit card), or that you can only spend that much on travel in a certain month. Think of it this way: you likely will not take a trip every month of the year.
Using my Budget After Thinking figures, let’s say I did not take a trip in January, February or March. That would mean that for my planned April trip, I would have $1,600 available that I can use, assuming I didn’t let those dollars disappear.
Later Money
Later Money is what you are saving, investing, or using to pay off debt.
This is the fuel for your most important goals.
When you’re in debt, this is the bucket that matters the most.
| Later Money | Baseline Budget | Budget After Thinking |
|---|---|---|
| Student Loans | $1,100 | $1,100 |
| Credit Card Debt | $150 | $900 |
| Savings | $0 | $50 |
| Pretax Retirement (401k) | $300* | $300* |
| Other Investments | $0 | $0 |
| Total Later Money | $1,250 | $2,050 |
*This was pretax money to my employer’s retirement plan. For budgeting purposes, it’s easier not to count the amount here.
What I learned tracking Later Money.
This is where all your efforts in tracking your spending and making thoughtful adjustments starts to pay off, IF you have a plan for your next dollar before you earn it.
My plan was to pay off debt as quickly as possible.
In my baseline budget, I was very good about paying my student loan debt in full every month. I knew enough not to mess with student loans.
The consequence was my credit card bills were the last to get paid each month. This usually meant only paying the required minimum since I had run out of money by this point. It also meant no money for savings or investments.
In my Budget After Thinking, because of the thoughtful choices I made with my Now Money and Life Money, I created $800 of excess cash.
With that cash, I had committed myself to paying off my credit card debt as quickly as possible.
I also wanted to start the habit of saving each month. So, I added $750 of fuel to my credit card bills and $50 of fuel to my savings.
I stayed true to my plan and put that money to work. Within a few years, I had paid off all of my debt.
Some bonus tips for tracking Later Money.
Make budgeting as easy as possible for yourself.
In my example, I excluded the $300 pretax retirement savings because I am creating a plan for the $7,500.00 that hit my checking account each month. These are the dollars in jeopardy of disappearing.
The entire point of your budget is to create a plan for your next dollar before you earn it. You already wisely chose to save your pretax dollars by enrolling in your employer’s retirement plan.
Those dollars are already accounted for and working for you. They are not disappearing dollars. You did your job!
Like in my example above, you can exclude the amount you’re saving for retirement in pretax dollars from your budget calculations.
Feel good knowing that you’re saving that money. It’s icing on the cake. No need to worry about it when budgeting.
Now you know how to make a budget to pay off debt.
Let’s look at the complete picture before and after I started the budgeting process:
| Baseline Budget | Budget After Thinking | |
|---|---|---|
| Now Money | $4,185 | $3,600 |
| Life Money | $2,100 | $1,850 |
| Later Money | $1,250 | $2,050 |
| Total | $7,535* | $7,500 |
*Income of $7,500
With some thought and relatively little effort, I was able to stop the disappearing dollars and start making progress towards my ultimate life goals.
In my baseline budget, I was spending more than I earned each month. That meant I had no money to pay my credit card bills, which kept getting bigger because I kept spending.
In my Budget After Thinking, I broke my habit of living above my means and generated $9,600 of fuel in one year to help pay off debt faster.
Taking these first steps may seem like minor steps on the way to financial independence, but they were the most important steps I ever took on my personal financial journey.
Like I did, you can follow these three steps if you are truly motivated to make a budget to pay off debt:
- Step 1: Track your spending for at least 3 months.
- Step 2: Separate your spending into 3 main categories.
- Step 3: Make adjustments so your spending better aligns with your true motivations and desires in life.
As you start to implement these steps, you’ll start to have a clearer picture of how your money can work for you.
When you’re in debt, that means putting your money to work for you to eliminate that debt.
The benefit to creating a Budget After Thinking is that it works whether you are in debt or you are focused on fueling other financial goals.
If you can put in the hard work now to create your budget, you’ll be in good shape no matter what you’re trying to accomplish.
Have you ever made a budget to pay off debt?
What was the key to successfully paying off that debt?
Let us know in the comments below.