Paying off debt can feel like an overwhelming process, especially when it comes to prioritizing which debts you should pay off first. If you want to prioritize debts for optimal impact, you’ll want to follow a few simple tips.
The first thing you need to look at when deciding how to prioritize your debts is your personal finances.
- How much of a debt load are you carrying? Are your monthly debt payments manageable? Or, are you struggling just to pay the minimum?
- What type of debts are you carrying? High interest credit cards? Auto loan? Home loan? Student loans?
- Do you have a savings account? Is your emergency savings enough to cover at least three months of expenses?
- Do you have financial responsibility for someone else? Minor children? A spouse who isn’t working? An elderly parent?
Your finances will play a big part in determining how you approach paying off your debts.
High Interest vs. Low Interest
As part of your debt repayment strategy, you want to pay off high interest loans first. Take a look at all of your debts to find out how much interest you pay. Focus the majority of your attention on the debt with the highest interest rate. While paying just the minimum on your lower interest debts, take your excess money and begin to quickly pay off the high interest debt. For example, if you have a credit card with 20% interest, an auto loan with 10% interest, and a student loan with 3% interest, you want to pay off the credit card first. This strategy will save you hundreds of dollars in interest. Once the first high interest debt is paid off, you should move on to the next high interest debt and so on.
Good Debt vs. Bad debt
Not every debt is bad for your credit rating and finances. In fact, debts such as student loans and home loans can help you gain better terms on other credit. For example, if you’re current on your student loan and home loan payments, you may get a favorable interest rate on an auto loan because you’ve proven your creditworthiness. Good credit (student loans and home loans) can raise your credit and shouldn’t be paid off too early, especially if you have other outstanding debt or plan to seek another line of credit.
Savings and Debt
Many debtors struggling to pay off bills wonder if it’s worth the trouble to save when they have so many outstanding debts to pay. Well, it’s absolutely critical that you have at least an emergency savings account that can cover three months of expenses. Emergencies are inevitable, you could lose your job, get sick, or your car could need a major repair. When emergencies happen, you don’t want to be dependent on credit cards or other debt instruments. You want to have your own cash on hand just in case the worse happens. On the other hand, if you already have emergency savings, you can divert excess cash to paying off your debts, especially if the interest you’re earning on your savings is less than the interest you’re paying on your debts.