Today’s guest post on paying off debts is sponsored by Credello.
If you have multiple debts you’re trying to pay off, you might feel overwhelmed. Which debt should you pay off first? Does it require high-level math (gulp) or a debt consolidation calculator?
Answers: It depends on your unique financial situation, you don’t need to be a mathematician (fear not, there are no riddles or word problems), and a debt consolidation calculator is very helpful but not absolutely necessary.
If you’re looking to find out which of your debts you should prioritize and how to pay them off, keep reading.
When to pay high-interest debt off first
Your highest-interest debt is typically unsecured debts (debts with no underlying collateral), such as credit cards. If you don’t make payments, your lender can’t take anything from you, though your interest will continue to accrue—often at a very steep rate—your credit score can tank, and you can also get hit with late fees. If you currently have any debts with interest rates that are in the double digits, you may want to focus on paying those off first.
If you’re not able to pay off these balances, it could take years (and a lot of extra money in interest) to finally pay them off. After all, you’ll save more by paying off a $3,000 credit card balance with an interest rate of 16% then you will by paying off your federal student loans with a 4% interest rate. Plus, federal student loans can offer tax breaks since you might be able to deduct a percentage of your interest when you file your taxes.
How to pay off high-interest debt
You can use the debt avalanche method to pay off high-interest debts. With the debt avalanche method, you’ll make minimum payments on all your debts, but you’ll put extra money toward your debt with the highest interest rate. Once that’s paid off, you’ll focus on paying off your debt with the next highest interest rate, etc. Since you’re eliminating your highest interest rates, the debt avalanche method can save you money overall.
When to pay the smallest debts off first
You may want to focus on paying off your smallest debts first if you feel like you need some motivation. This study shows that knocking out smaller debts first can give borrowers momentum in their debt payoff journey and can help them stay motivated. Even though favoring high-interest debts over the smallest debts will likely save you money in interest, it doesn’t have the same emotional impact.
How to pay off smallest debts first
You can use the debt snowball method to knock out your smallest debts. With the debt snowball method, you’ll make minimum payments on all your debts, but you’ll put extra money toward the smallest balance. Once you’ve paid it off, you’ll put extra money toward the next smallest balance. The debt snowball method can be very motivating since you’re crossing your debts off one at a time and can be a good fit for individuals who need some positive reinforcement.
When to pay the secured debt off first
Secured debts are debts tied to physical collateral, like your house or car. If you fall behind on unsecured debt payments, your money owed in interest can exponentially increase (among other downsides), but the lender can’t physically seize anything. However, if you fall behind on your housing payments, your home could be repossessed. If you’re in danger of defaulting on any of your secured debts, you may want to tackle those payments first.
And there you have it: how to figure out which debts to pay first, no calculus or trig required. It doesn’t matter which payoff method you pick; what matters most is that you stick with it. Keep calm and stay focused—we know you can do it.
Harvard Business Review