Its best to tackle tax debt and debt in collections first to avoid legal issues. After that, consider these strategies:
It can be difficult to decide which debt repayments to prioritize when you have a lot of debt. To avoid legal issues, its best to prioritize any tax debt or debt in collections. Beyond that, your approach may depend on your financial situation, objectives and long-term goals. For example, you might want to pay off your car loan first so you can stop making car payments, or you might want to take care of your mounting credit card debt.
Whichever strategy you choose for paying off your debts, the most crucial thing is to make a plan and stick to it in order to achieve your goals. Here are five strategies you can consider to determine the best path forward for you.
Juggling multiple debts can feel overwhelming, especially when you’re unsure which one to tackle first. Should you prioritize the oldest debt or the newest one? The answer might surprise you.
The Debt Snowball Method: Focus on the Smallest Debt First
While conventional wisdom might suggest focusing on the debt with the highest interest rate, the debt snowball method advocates for paying off the smallest debt first. This approach, popularized by financial guru Dave Ramsey, prioritizes the psychological boost of eliminating smaller debts quickly.
Here’s how the debt snowball method works:
- List all your debts: Start by listing all your current debts, including credit cards, loans, and other obligations. Include the current balance and minimum payment for each debt.
- Order by balance: Sort your debts from the smallest balance to the largest.
- Focus on the smallest debt: Make the minimum payments on all your debts, but put any extra money towards the smallest debt.
- Celebrate and repeat: Once you’ve paid off the smallest debt, celebrate your victory and move on to the next smallest debt.
Benefits of the Debt Snowball Method:
- Motivation: Seeing small debts disappear quickly can provide a powerful boost of motivation to keep going.
- Psychological impact: Eliminating smaller debts can give you a sense of accomplishment and encourage you to stay on track.
- Flexibility: You can easily adjust this method to fit your financial situation and goals.
When to Consider Paying Off the Highest Interest Debt First
Although many people find success with the debt snowball method, in certain circumstances it may be preferable to pay off the debt with the highest interest rate first:
- High-interest debt: If you have a debt with a very high interest rate, such as a payday loan or a credit card with a 25% APR, it might make sense to focus on paying that off first to avoid accruing more interest charges.
- Debt with late fees: If you’re struggling to keep up with the minimum payments on a debt with high late fees, it might be best to prioritize that debt to avoid further penalties.
- Debt with a short payoff period: If you have a debt with a short payoff period, such as a personal loan with a 2-year term, it might be more efficient to focus on paying that off first.
Ultimately, the best approach for you depends on your individual circumstances and financial goals. Consider your financial situation, risk tolerance, and psychological needs when deciding which debt to pay off first.
Additional Tips for Debt Repayment:
- Create a budget: Track your income and expenses to identify areas where you can cut back and free up more money to put towards debt repayment.
- Automate your payments: Set up automatic payments to ensure you never miss a payment and avoid late fees.
- Negotiate with creditors: If you’re struggling to make payments, contact your creditors to see if they’re willing to lower your interest rate or monthly payment.
- Seek professional help: If you’re feeling overwhelmed by debt, consider seeking help from a financial advisor or credit counselor.
Remember, getting out of debt is a marathon, not a sprint. Be patient, stay focused, and celebrate your progress along the way.
Concentrate on Revolving Debts
A high credit utilization rate, which can lower your credit score, can be caused by credit card debt or a line of credit. Prioritizing your revolving debts will help you reduce your utilization rate and raise your credit score.
Furthermore, the minimum payment on revolving debts is usually low, and paying only this amount significantly extends the time it will take to pay off these accounts. Tackling them first can eliminate the potential for these accounts to disrupt your debt payoff plan.
Finally, revolving debts typically come with variable interest rates, which fluctuate over time. Paying off revolving debt first can help you reduce the impact of rising interest rates on your budget if rates are rising.
Prioritize Debt With the Highest Interest Rate
Prioritizing debt with the highest interest rates can potentially help you save more money on interest. Credit card debt is probably the highest-interest debt you have, but there are other accounts that can have extremely high interest rates, like payday loans. Review the terms of each account to see which ones have the highest interest rates.
You can prioritize your high-interest accounts using the debt avalanche method. This is how it operates: Pay the minimum amount due each month on all of your accounts, with the exception of the one that has the highest interest rate. With that account, put all of the extra money you can afford to pay it down faster.
After you’ve paid off the entire amount owed on the account with the highest interest rate, take all of the money you were contributing each month and apply it, along with the minimum payment you were already making, to the account with the next-highest rate. Again, youll continue to pay just the minimum on your other accounts.
Repeat this process with each account until all of your debt is paid off.
Should You Pay off Debt OR Save for Goals First?
FAQ
Which debt should be paid off first?
Is it better to pay off old debt or new debt?
Should you pay smallest debt first?