Which Debt Should You Pay Off First?
The average American has $5,525 in credit card debt, according to a 2021 Experian report. This doesn’t include additional debts, such as mortgages, car loans, and student debt. A lot of consumers are trying to pay off multiple credit accounts simultaneously.
Debt can be a difficult thing to manage. You may have multiple debts that you are trying to pay off, and it can be hard to know which one to focus on first. Which debt should you pay off first? The one with the highest interest rate? Or the one that is the smallest balance?
There are many ways to pay down debt, but it may be best to focus on some debts before others. Making small monthly payments across all your debt could result in paying more interest over time. Once a debt repayment method is chosen, the most important thing to do to become debt-free is to stick with it.
Option 1: Pay Off The Debt With The Highest Interest Rate First
- Key advantages: Saving money is important, but it’s not the only thing that matters when it comes to your finances.
- Key drawbacks: Debt can be daunting, especially when it seems like it will take forever to pay off. But don’t get discouraged- focus on chipping away at the debt with the highest interest rate first.
- Best for: Minimizing the amount of interest you pay.
High-interest debt can be a major burden, but you can take steps to pay it off quickly. The avalanche method focuses on paying off the debt with the highest interest rate first. This can help you save money in the long run and get rid of your debt more quickly. To do this, make the minimum payments on all of your debts each month, but put extra money towards the debt with the highest interest rate. You may need to cut back on spending in other areas to free up extra money to put toward your debt. But by taking these steps, you can get rid of your high-interest debt and move on with your life.
The debt avalanche method is often lauded as the smartest way to pay off debt. However, it’s not always the best option for everyone. For example, people with many debts may not have extra money to put toward their highest-interest debt. The avalanche method can also be discouraging for people with large debts, as paying it off can feel impossible.
Make the minimum payments on all your accounts each month. Any extra funds left over should be applied to the credit card with the highest interest rate. Once that balance is paid off, focus on the next highest interest rate card, and so on. Repeat this cycle until all balances are paid in full.
Option 2: Debts Should Be Paid Off In Order Of Size
- Key advantages: Helps build motivation and encourages you to stick with the plan.
- Key drawbacks: It may take longer to become debt-free, and you could pay more in interest.
- Best for: People who struggle to stay motivated with paying off debt.
Debt repayment can be a daunting task, but different methods can be used to make it more manageable. Some people choose to focus on paying off the debt with the highest interest rate first, whereas others may opt to pay off their smallest debt first and gradually work their way up to the larger ones. The latter method, popularized by financial guru Dave Ramsey, is often referred to as the “debt snowball” approach since it starts small and gradually builds over time.
Paying off your debts in full can be a great motivator to keep working towards your financial goals. By paying off your smaller debts one by one, you free up more money to put toward your larger debts. Although you may end up paying more in interest this way, sometimes the psychological benefits of getting those smaller debts paid off as quickly as possible can be very rewarding.
To get started with your debt snowball, list all of your current debts – and their current balances – from low to high. Make minimum monthly payments on all of your debts while putting as much extra money as possible toward your smallest debt. Once that debt is paid off, put your extra money towards your next-smallest debt, and so on. Keep building up your debt snowball until you’re finally debt-free!
Option 3: Maintain A Good Credit Score By Paying Debts That Are Most Likely To Affect It
- Key advantages: As your credit score improves, so too will your opportunities to qualify for lower APRs and increased spending limits.
- Key drawbacks: Credit scores are important, but they can be hard to improve. Making lifestyle changes to improve your credit score can be tough, and it’s easy to lose motivation.
- Best for: Individuals seeking to finance a substantial purchase, such as a home or vehicle.
Your credit score is like a financial blood pressure reading. It’s important to monitor your score, especially when your finances might not appear compatible with your lifestyle. A good credit score can help lenders understand how well you manage your finances. Your credit score is affected by factors such as how much debt you have, the number of open credit lines in use, and your payment history.
A favorable credit score and credit history will be necessary for major purchases like a new home or car. Your credit utilization (the amount of your credit limit on revolving accounts compared with what you’re using) should be below 30%, and all your accounts should be current. Any payment delinquency will make a mortgage loan officer or other lender reconsider whether or not they want to extend a loan offer to you.
Having a high credit score has many benefits that can help you in your financial life. For example, you may be offered lower interest rates on loans and credit cards, and you may have more opportunities to get approved for loans with zero-down deposits. Additionally, your spending limits on credit cards could be increased, and financial institutions may extend other attractive offers to keep your business.
Improving your credit score may require making some lifestyle changes to pay off debt. This can be difficult, as it may mean giving up things that you are used to, such as daily takeout lunches or impulsive shopping. However, making these sacrifices can help improve your financial situation and reduce debt.
It is important to keep your credit utilization low to maintain a good credit score. You can do this by paying down your high utilization rate credit cards. Start with the cards that have utilization rates over 30 percent. In this case, you have two cards that fit this criterion — credit card #1 with a utilization rate of 75 percent, and credit card #2 with a utilization rate of 50 percent. Reducing the utilization of these two cards will give you the best chance at improving your credit score, as long as you pay all your other bills on time.
Option 4: Be Balanced In Your Approach
- Key advantages: There are many advantages to creating your debt repayment plan. One of the biggest advantages is that it can help you stay on track to becoming debt-free.
- Key drawbacks: It can be easy to lose motivation when you don’t have a clear strategy.
- Best for: For those who need more flexibility in their lives but still want to stay motivated, there are options available.
When it comes to paying off debt, there is no one-size-fits-all approach. Some debts are more pressing than others, and you may have to prioritize accordingly. For example, a debt that has gone into collections may take precedence over a smaller debt. Or, you may want to focus on paying down a debt that offers tax deductions for the interest you pay. Ultimately, the decision of which debts to repay first is a personal one. You can use any of the three debt repayment options we mentioned – paying off the largest debt first, making minimum payments on all debts, or focusing on debts with high-interest rates – in whichever order you see fit.
Option 5: Debt Consolidation
- Key advantages: Debt consolidation could save you money on interest, simplify your finances and help get rid of debt faster.
- Key drawbacks: The potential for upfront costs exists, and you may not qualify for a lower interest rate.
- Best for: Different ways of making monthly payments with high APRs.
There are a few different ways to consolidate your debt into one monthly payment. One option is to transfer your existing credit card balances onto a balance transfer credit card. Many of these cards come with 0% APR periods lasting for 15-21 months, which can give you plenty of time to start paying off your debt without accruing any interest on your transferred balance.
Another option is to take out a personal loan and use that money to pay off high-interest debt. While this will still require repaying the personal loan, it may be a way to lower the overall cost of your debt repayment process by finding a loan with considerably lower interest rates. Use a debt consolidation calculator to figure out how much could be saved by taking out a personal loan.
You may want to consider consolidating your debts by taking out a home equity loan or line of credit. A home equity calculator can help you determine whether this would save you money in the long run. Keep in mind that falling behind on mortgage payments can risk foreclosure, so be careful before taking out a second mortgage.
Which Debt Should You Pay Off First?: Final Thoughts
When you’re trying to pay off debt, there are a lot of different strategies you can use. The best strategy for you depends on your financial situation and what will keep you motivated. Just make sure whatever plan you choose is realistic, put it in writing, and commit to taking action and staying the course until you reach the finish line.