Managing Debt Wisely: Budgeting And Creating A Repayment Plan

Budgeting has become associated with cutting back, creating a negative connotation around the word. But budgeting is simply preparing a plan. A well-crafted budget helps you identify where your money goes, prioritize expenses, and allocate funds toward debt repayment. A strong budget also keeps you organized, supports your repayment plan, and builds the discipline required to manage debt successfully.

The most critical aspects of budgeting are:

• Understanding Your Income

Getting a clear handle on your monthly income is the first step. Start by listing all sources of income, including wages, freelance work, side gigs, rental income, and any other earnings. This may be easy if all of your income sources are predictable and steady. If this isn’t the case, then you may have to either build your budget based on an estimate of your monthly income, or have multiple versions of your budget depending on the various ranges your income may fall within.

• Understanding Your Expenses

To start budgeting your expenses, compile a list of your usual monthly expenses (based on a review of recent actual months), broken down into essential and discretionary categories.

Essential expenses are fixed or necessary expenses, such as rent or mortgage, utilities, groceries, transportation, insurance, and debt payments. Covering these is your top priority.

Discretionary expenses include non-essential spending, such as dining out, entertainment, and hobbies. Reducing discretionary spending can create more room for debt repayment and savings. However, for most people it’s unrealistic to prepare a budget that doesn’t allow for any discretionary spending. This is an area where you may have to consider what is most important to you to properly prioritize your spending.

If you’re unable to cover your non-discretionary expenses and a reasonable amount of discretionary spending without a budget shortfall, you will need to find ways to increase your income or spend less on your necessary expenses.

Once you’ve established a budget, you have the basis to create a debt repayment plan. Your budget tells you how much you can allocate to debt re-payment each month. The re-payment plan tells you where to direct those payments.

The two most popular strategies for managing debt are the Debt Snowball and Debt Avalanche methods, though a Hybrid Approach may also be right for you.

• Debt Snowball Method: This involves paying off the smallest debt balances first, regardless of interest rate. The benefit of this method is that it can help keep you motivated, as quick wins (in the form of paying a debt off completely) can provide a strong psychological boost. As each small debt is paid off, you might find that you gain momentum and build confidence.
• Debt Avalanche Method: Here, you prioritize paying off debts with the highest interest rates first. This approach saves more money in the long run by reducing the amount of interest paid, meaning that more of your debt re-payment dollars can start going to reducing the principal balance sooner. While it may take longer to see each individual debt eliminated, the avalanche method can shorten the overall repayment time.
• Hybrid Approach: Some people benefit from combining the above methods. They may start with a quick win by paying off a small debt to gain momentum and then switch to targeting the debt with the highest interest rate.

Both approaches can be effective, so choose the one that best aligns with your personality and motivation. Regardless of the method you choose, consistency is the key to long-term success.

Once you’ve determined your plan, consider automating your debt payments to ensure you never miss a payment, avoiding late fees and penalties. Set your debt payment timing to align with your income cycle to reduce the risk of overdraft fees or cash flow issues.

In addition to budgeting a specific amount that you can afford to pay each month, you can also consider dedicating any windfalls, such as bonuses or tax refunds, to debt reduction based on the debt re-payment plan you’ve set up.

Your budget should be a flexible tool that adapts to changes in your financial situation. Regularly reviewing and adjusting your budget, especially after you’ve experiences life changes that impact your income or expenses, can help you identify additional ways to cut expenses or increase income, accelerating your debt repayment progress. Likewise, you may want to revisit the debt re-payment method you’ve chosen if you find yourself losing motivation.

Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the southern Alberta region. We regularly help individuals navigate their options for dealing with their debt. If you'd like a free, no-commitment consultation to review your options, contact us.

Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.