How to Budget to Pay Off Debt

Having a budget can help you reach your debt repayment goals faster and more consistently by giving you a structure that you can use to allocate your money as needed.

With a comprehensive budget, you have a solid grasp of how much money you’re earning each month, how much you’re spending, and where you’re spending it. It also helps you determine how much money you can allocate towards debt repayment and how much you can apply to savings (such as emergency funds) and investments (such as retirement accounts). 

It also lets you know how much extra you have in the budget to spend on “nonessential” expenses like vacations or entertainment.

In this article, we’ll cover how to get a solid understanding of your debt, how to make a budget to pay off your debt, and effective debt repayment strategies so you can be debt-free and worry-free.

Understanding Your Debt

Debt can be categorized as either secured or unsecured.

• Secured Debt. This refers to any form of debt that is backed with some form of collateral. For example, the collateral on an auto loan would be the vehicle while the collateral on a mortgage would be the home.
• Unsecured Debt. This is debt that is not backed by collateral of some kind. Credit cards are an example of unsecured debt. Interest rates on unsecured debts are often higher since there is no collateral to offset the lender’s risk.

So, which types of debt should you prioritize? Here are a few debt examples to help you determine which debts to pay down first:

Which of these debts should you pay off first? If your goal is to minimize money spent on interest charges, payday loans should be paid off first. Next would be credit card debt. Meanwhile, for auto loans and mortgages, enough money should be set aside to meet your minimum monthly payments.

However, if your financial priorities are to qualify for another loan (like a consolidation loan), increase your credit score, or lower credit utilization you may want to prioritize paying down other debts first, since payday loans don’t report to credit bureaus. 

How to Make a Budget to Pay Off Debt

When setting up a budget to pay off your debt, it’s important to begin with an analysis of your income and expenses. Here, free tools like Credit Canada’s Budget Planner can be helpful.

One traditional way to budget is to follow the “50/30/20” rule. What this means is that of the money you earn:

• 50% would go towards “needs” like housing costs, food, your vehicle, etc.
• 30% would go towards “wants” like entertainment, travel, subscriptions, etc.
• 20% would go towards savings and debt repayment.

How do you determine how to categorize needs vs wants?

“It is so easy to confuse a need and a want, especially if it’s something that we really want. So, the easy way to keep in mind the difference between needs and wants is do I need this to survive?” ~Jordann Kaye, Personal Finance Writer

Finding the right balance between repaying your debts and saving for the future (or even for your personal financial goals) is important.

In addition to the 50/30/20 rule, there are other budgeting systems, such as “zero-based budgeting,” which looks to use every dollar you earn in some form—even if the spending is in the form of contributions to debt repayment, savings accounts, or investments.

There’s also the “money-bucket system,” similar to the envelope system, where you set up different bank accounts or envelopes for different expense types to put a hard cap on your spending for each type of expense.

When setting up your debt repayment plan, try to set a goal that follows the SMART framework (i.e., a goal that is specific, measurable, achievable, relevant, and timely). An example would be “Pay off my student loan within the next ten years.” This helps you stick to your repayment plan for the long term.

Budgeting doesn’t have to be overwhelming. Butterfly is a free app created for newcomers, but it's great for anyone who wants to track spending and set goals.

Effective Debt Repayment Strategies

Once you know what your income and minimum monthly expenses are and how well they align with the 50/30/20 rule, it’s time to choose a debt repayment strategy. Here are two different repayment strategies to choose from:

• Snowball Method. Pay as much money as possible towards your smallest debt, regardless of the interest rate, while maintaining just the minimum payments on your other debts.
• Avalanche Method. Put as much money as possible into your highest-interest-rate debts first while maintaining the minimum payments on other debts. 

These methods have different benefits. For example, the avalanche method tends to save you more money in the long run, while many find it easier to stay motivated with the snowball method since debts disappear faster when you focus on the smallest ones first.

Tips to Enhance Your Debt Repayment Strategy

To help improve your debt repayment strategy, consider following these tips:

• Reducing Expenses. To help free up room in your budget for clearing your debts more quickly, identify unnecessary expenses and reduce them as much as possible. Reducing expenses allows you to dedicate more towards your debt payments so that your debt is paid down faster.
• Using “Side Hustles” to Increase Your Funds. Bring in more money by participating in the gig economy (companies like Uber, Turo, Skip the Dishes), reselling old collectibles online, or making goods to sell yourself on platforms like Etsy. Just be sure to file your taxes from your side hustle!
• Using Windfalls to Clear Debts First. When you come into a lump sum of money (such as from an inheritance or a lottery win), it is often best to use that money to pay off your credit cards or other high-interest debts rather than save it up or spend it. 
• Leveraging Debt Consolidation. Debt consolidation is when you take multiple debts and combine them into a single payment. This can include debt consolidation loans, debt consolidation programs/plans (DCPs), or rolling debt into your mortgage. 

“We do not see managing debt as an area of savings. However, the best way to save is to eliminate debt.” –Mike Bergeron, Credit Counsellor, Credit Canada

Maintaining Your Budget and Debt Plan

After you’ve settled on a debt repayment strategy (or a combination of strategies), it’s important to stay on track with your repayment plan. Some quick tips for holding to your budget include:

• Get Help. Maintaining a budget can be hard. But you don’t have to do it alone. Looking for help, either from friends and family members or professionals like accountants, financial advisors, or non-profit credit counsellors, can help you stay motivated and find better ways to manage your finances to get (and stay) out of debt.
• Periodically Review Your Debt Situation. Keep track of each of your debts and review them at least once a year so you can address changes to your debt situation and shift priorities as needed to keep your repayment plan on track.
• Use a Budgeting App. There are apps that you can download on your smartphone or other mobile devices that can help you keep track of your spending habits, alert you when you’re going over budget, or find opportunities to reduce your expenses. Many financial institutions have their own dedicated app for this.
• Set Up Payment Reminders. Create reminders on your calendar about your payment due dates to avoid missing payments on your debts.
• Use Automated Payments, if Available. To make it easier to consistently make payments, consider setting up automated payments to creditors. 
• Consolidate Your Debts. The fewer debts you have, the easier it will be to keep track of them and make payments. Consolidating debts helps shrink the total number of payment due dates you have to track.