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How to Prioritize Debt Repayment

Congratulations on wanting to get all your debts repaid. One of the best things you can do when trying to pay off multiple debts is to get organized. Paying off various loans and credit cards can become a mess of minimum payments and amounts due if you don’t pay close attention. But which accounts should take priority?

Planning the Takedown: Deciding Which Debt to Pay Off First

Prioritizing debt repayment helps you decide which opponent to take out firstThis can be a tricky question to answer. For many people, it depends on how they respond to paying off different debts because the main key is to keep going until all debts are fully paid. The trick with most of these strategies involves paying down the principal of the loan by allocating more money to the debt you want to pay off first.

4 Strategies to Pay Off Debt

When it comes to your other debts, there are four basic strategies for debt repayment.

  1. Paying off the smallest balance first.
  2. Paying off the debt with the highest interest rate first.
  3. Paying off the largest balance first.
  4. Consolidating debts to one loan or card to eliminate multiple payments and have one single loan with a smaller interest rate.

Paying off the smallest balance first

This, as with most repayment plans, is pretty straightforward. You will need to look through your debts and prioritize the one with the smallest balance. While you continue making minimum payments on your other debts, put more money toward the one with the smallest balance. You will repay this debt sooner, allowing you to cross one loan off your repayment list.

This is called snowball debt repayment, because after you pay off the first loan, that money can then be snowballed into the next smallest payment so that you can pay off that loan sooner – like rolling up a snowball. Some people prefer this option because there is a sense of accomplishment in paying off a debt. Paying off the smallest balance allows you to reach a repayment goal faster. This method often helps you stay motivated, so you can keep up repayment until you reach the end.

Paying off the debt with the highest interest rate

Part of the reason loans and credit lead to debt problems are interest rates. The higher the interest is on a particular type of credit, the more you will have to pay back when you carry a balance.

Making larger payments toward the loans with the highest interest rates is called avalanche debt repayment. This is because you will wind up paying less overall once the higher interest debts are paid off, causing your debt to come “tumbling down,” which in turn saves you money.

This method will save you more money in the long run, because you pay less interest overall. However, it can be hard to do because getting out of debt is often as much an emotional journey as it is financial. If your highest interest rate debt is also one of your biggest balances, it can take a while to pay off.

This can be discouraging for someone to be paying down a high interest loan month after month without seeing much of a change in their overall debt load, but if the goal is to pay off your overall debt faster and with lower total interest charges, this is the way to do it.

Paying off the largest balance first

For some people, the debt that carries that largest balance is the thing that’s driving them crazy. It creates stress and you constantly think about that albatross around your neck. So, although it’s usually not the path that’s taken the most, you can decide to eliminate debt by largest balance first. This means you make the minimum payment requirements on everything else, then focus your attention on knocking out that big balance.

The challenge with this method is two-fold:

  1. If your largest balance has a low interest rate, this method is not as cost effective. That’s because you waste money on interest charges by not focusing on high APR first.
  2. It can be tough to stay motivated. You don’t immediately eliminate any bills or provide any relief to your budget, so it feels like your still stuck in neutral.

With that in mind, this method is only recommended if you are not struggling to pay bills.

Putting things together by consolidating your debt

Debt consolidation puts the pieces together to pay off debtIf you can’t choose or if all your debts have similar high interest rates, another option for debt repayment is to consolidate. By consolidating your debt, you can fit multiple debts into one payment at the lowest interest rate possible. Putting the pieces together makes it easier to pay off more of your debt faster and with lower total costs.

Options for consolidating your debt can either be with a personal loan or by getting a balance-transfer credit card.

Balance transfer credit cards offer lower interest rates — sometimes zero percent! — for a set period, usually 12 to 18 months. Most have a balance transfer fee between 3 percent and 5 percent, but you can sometimes find no-fee versions. The trick is to make sure you continue to pay down as much of the debt as you can each month toward the one large debt, which will eliminate more of your principal balance. It’s best if you can pay off the whole thing within the timeframe of the no- or low-interest promotion.

Sometimes that can’t be done. If this is the case with your debt, at that time you could seek out another balance transfer card or hopefully you have shrunk your debt enough that you could continue to pay more toward your principal balance than towards interest charges.

If you have a low-interest rate personal loan, it will likely have a longer term than the low-interest rate on a balance transfer credit card, but the rate might not be as low. Lumping your debts is one way to keep your debts consolidated in one place so that you only have one payment with less interest each month.

The other advantage to a low-interest debt consolidation loan is that you can take care of multiple types of debt at once. You can actually use a debt consolidation loan to consolidate credit card debt, personal loans, and even tax debt. In some cases, you can also roll auto loan debt into a debt consolidation loan. This allows you to simplify your debt repayment calendar by putting almost everything into a single bill.

Just to note, many student lenders will not allow you to consolidate student loans with other types of debt. Student loans tend to have different rules for repayment and lower interest rates. There’s also restrictions on discharging student loan debt during bankruptcy. So, you generally have to consolidate student loans separately.

Methods to Pay Off Debt

To help understand these four different options, here is an example of what your debts could look like.

DebtBalanceAPR
Credit Card 1$5,00022%
Credit Card 2$10,00017%
Credit Card 3$2,00018%
Personal Loan$7,0009%
Student Loan$18,0007%

Debt repayment using the snowball method

If you use the snowball method, you would organize your debts for repayment as follows:

  1. Credit Card 3
  2. Credit Card 1
  3. Personal Loan
  4. Credit Card 2
  5. Student Loan

While you continue to make minimum payments on the other debt, you would put as much as you can toward Credit Card 3. Even though the interest rate isn’t as high as some of the others, paying it off would eliminate one debt overall. Then that lets you put the extra money toward the next smallest debt to pay it off faster. You also get the emotional satisfaction of paying off an entire debt.

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Debt repayment using the avalanche method

Using the avalanche method, you would organize your debts for repayment as follows:

  1. Credit Card 1
  2. Credit Card 3
  3. Credit Card 2
  4. Personal Loan
  5. Student Loan

Because the interest rate on that card is so high, paying more money toward the debt will save money long-term. Then you can put the money you free up towards eliminating your other debts. If you could afford to pay $300 a month on this card, you would pay off the debt in 13 months. That saves almost $6,000 in interest charges had you only been paying the minimum.

After paying off this card with the highest interest rate, you would move on to the next highest rate and so on. This method saves you the most money over time. However, it can sometimes be hard emotionally for someone who is not seeing a payoff sooner.

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Repayment that pays off the largest debt first

Using this method, you would organize your debts for repayment as follows:

  1. Student Loan
  2. Credit Card 2
  3. Personal Loan
  4. Credit Card 1
  5. Credit Card 3

This method is used the least because it neither accomplishes the goal of “crossing something off the list” or saves on high interest rate payments. However, if it is the largest debt and also has one of the highest interest rates, you would largely be following the avalanche method. In this case, you could save yourself a lot of money by avoiding interest charges on such a large sum.

Consolidating your debts

Using debt consolidation, you would pay off the debts in one of the following ways:

Option 1: Consolidating all debts besides the student loans together

  1. The personal loan and three credit cards would be consolidated into one payment
  2. Since the total amount would be $24,000, that’s more than you can pay off effectively during a balance transfer introductory period.
  3. Let’s say you qualify for a debt consolidation loan at 8% APR because you have excellent credit.
  4. Since that’s still higher than the student loan, you’d pay off this consolidated debt first.
  5. With a term of four years, the monthly payment would be around $586; with a 36-month term, the monthly payment would be around $752.
  6. This allows you to pay off all your other debts in 36-48 payments, leaving only the loan to repay.

Option 2: Consolidating all credit card debt with a balance transfer

  1. Use a balance transfer to consolidate the three credit card debts into one payment
  2. With excellent credit, let’s say you get a card that offers 0% APR for 18 months.
  3. That gives you 18 months to pay off $17,000 in debt interest-free.
  4. If you could afford payments of $950, you’d eliminate the debt in-full during the 0% APR period.
  5. That leaves the two loans to repay, freeing up all the money you were using for credit cards.

Not sure on the best way to consolidate your debt? Talk to a consumer credit counselor at no charge for a free evaluation

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Don’t Forget “Important Debts”

Tax Debt: The one type of debt you don’t want to linger

This is not exactly a repayment strategy, but it’s important to understand who you owe money to. That’s especially true when the collector you owe is the IRS.

If you have tax debt, then repaying it should fall as the most important debt on your priority list. That’s because the has the ability to garnish your wages and put liens against your property. In addition, penalties and interest charges continually accrue, even if you qualify for Currently Not Collectible status or enroll in an Installment Agreement. So, it’s critical to pay off this debt before all others and to pay off it as quickly as possible.

If you owe back taxes, put them at the top of your list. You don’t want to keep adding to what you already owe!

If you have tax debt, Debt.com can connect you with accredited tax debt resolution services, so you can get relief and stop IRS collection actions now.

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Mortgage and Auto Loans: Pay first, pay off last

It’s worth noting here that paying off first is a separate concern versus paying first. If money is tight and you’re deciding which bills to pay first, you pay first on anything that affects your life and livelihood. This includes debts like your mortgage and auto loans. You don’t want to lose your house or lose the car you use to get to work.

On the other hand, these types of debt should be paid off last. They’re fixed payments that you can afford, so they generally cause the least problems for your budget. As a result, you should pay the bills on time as scheduled, but don’t worry about paying them off until you’ve eliminated everything else. Then you can decide if you want to devote extra cash to paying off your auto loans and then your mortgage.

What about medical debts?

Medical debts also need to be repaid, but aren’t as important as tax debts. Work with your provider to pay whatever you can afford each month or try to negotiate the amount due to see if they would be willing to write off some of your debt. You can also explore putting these debts into a debt consolidation plan, because you can usually consolidate them, too.

Stick to It!

The most important part about creating a debt payoff plan is to stick to it. Make sure you pay all your debts each month and don’t incur too much more debt along the way. As long as you stay with your plan, you will eventually get to celebrate being debt free. And remember, the better you are at prioritizing debt payoff in a way that fits your financial state of mind, the more likely you are to be successful.

If you want help prioritizing your debts, visit Debt.com’s Solutions Center or check out our debt repayment calculator.

Article last modified on June 12, 2018. Published by Debt.com, LLC . Mobile users may also access the AMP Version: How to Prioritize Debt Repayment - AMP.