Wondering Which Debt to Pay Off First? Here's How to Decide
Debt is a fact of life for most of us, whether it's a mortgage, a student loan or a credit card we don't pay the entire balance on each month. When managed well, debt can be a normal part of life that helps us achieve our goals. But when debts start to pile up, they can quickly leave us feeling stressed and overwhelmed.
As with most problems, the only way to address an excess of debt is to tackle it head on. The first step is deciding which debt to pay off first. Should you start with your credit card debt, clear your mortgage or take a different approach?
Not all debt is created equal
Debt isn't always bad—there's a difference between good and bad debt. Take student loans as an example. People with college degrees tend to land higher-paying jobs than those with high school diplomas. So, the debts you take on to put yourself through college may pay off through greater job satisfaction, a higher salary and better benefits.
Similarly, a business loan can help you build a profitable business and become your own boss. And getting a mortgage means you'll own your own home, which is usually better value than renting because you can build equity.
But debt also comes with downsides. For example, you may end up paying high interest on things that'll go down in value, such as a new car or clothes that you purchase with a credit card. This is especially true of cards that have higher interest rates, such as store credit cards.
Knowing where you stand
If you find yourself juggling multiple debts, you're far from alone. Most of us can't afford to buy a car without a loan, for example, and it's all too easy to use a credit card to make a purchase that we later regret. Luckily, there are steps you can take to get things under control.
Having a firm grasp of where you stand will make it much easier to get the process started. Use a spreadsheet or personal finance app to make a full accounting of your outstanding debts. List the debt, the outstanding amount and the interest rate, keeping in mind that your interest rate and APR may differ.
Which debts to prioritize
Once you've listed all your debts, you can use the spreadsheet to sort them by interest rate. High interest means that the longer you take to pay the debt, the more expensive it becomes. Paying off these debts first may be the fastest way to relieve some financial pressure. You can use a debt repayment calculator to see how long it will take to pay off a debt based on your monthly payments.
You may find that your highest-interest debts are also your biggest, which means they could take several months or longer to pay off. That's why another school of thought suggests starting with your smallest debts first. The reasoning here is that you can pay these debts off more quickly. You'll feel like you're making progress, which will help you stay motivated.
Some debts, such as mortgages and student loans, tend to have lower interest rates and more affordable monthly payments. Interest on these may also be tax-deductible, so they could have the benefit of lowering your tax bill. You may want to stick to the minimum monthly payments on these while you pay off higher-interest accounts, such as your credit cards.
If you're paying high interest, struggling to meet monthly payments or paying installments on a purchase that's decreasing in value, prioritizing these debts is a good place to start your efforts. The sooner you take action, the quicker you'll feel like you're in control of your finances.
