Which Debt Should You Pay Off First?

The consequences of not paying off some debts before others can lead to more financial hardship.

Carlos was making a six-figure salary as a Logistics manager in Georgia when in the summer of 2013 he realized he couldn't afford to take his family of four on vacation.

When he and his wife finally took stock of their debt, they realized they owed $70,000, spread across six credit cards.

They were living paycheck to paycheck, and simply kind of naïve. “We really didn't know which debt to pay off first. Therefore, that's what led to our indecision about addressing our debt for so many years", they acknowledged.

Carlos, who now runs a home-based logistics firm, said he and his wife sat down to figure out where their money was going. They discovered ways to save, his wife went back to work, and they came up with a methodical payment plan. As a result, four years later, they were almost debt–free and had activated their plan to pay cash for all future vacations.

Carlos’s family story isn't unique.

The average U.S. household credit card debt totals over $8,187 in 2018, according to my friends at the Balance with more outstanding for auto loans, home loans, and student loans. If you're ready to take control of your finances, start by honestly assessing your total debts, and decide which debt to pay off first.

Related: Too Much Credit Card Debt? Here's How To Fix It

Making an informed decision about paying off the money you owe is always a befitting cause – but satisfying some debts before others will benefit you far more than you might think.

When I completed my debt pay off plan, it helped me save money over the life of my loans. As someone who has had my share of multiple debt accounts, here are a few questions that I asked myself when prioritizing which debt to pay off first.

What is my goal?

The goal is to determine which debts to pay off first in a set amount of time, credit cards or loans. Having multiple credit cards or loans requires prioritizing each card or loan. The first step is to fully understand the kind of debt you’re dealing with.

You must shift your focus from the problem of total debt onto a smaller goal that is meaningful. Therefore, focus on achieving the goal and it takes your mind away from the size of the larger problem.

Your goal should create inspiration and excitement for you. Paying off debt is a personal dream, a vision that ignites action. I often ask myself “how much am I willing to invest in the process?”  You must be willing to invest yourself fully in the process.

Sometimes along the way, you will need to remind yourself, or be reminded of what inspired you to start your goal. It helps to write down your goal and revisit it if need be.

What is the current reality?

text the real life with blue cloud background
Image by Alexas-Fotos

Clarify your current debt situation. When the reality is clear, it brings the goal into sharper focus. When I have a real talk with myself I am descriptive and non-judgmental. I search for honesty and accuracy. You might ask yourself, “What action have I taken on this so far?” followed by “What were the effects of that action?” I usually celebrate myself when my actions are working well and you should also.

Often times, through investigation of reality leads to the solution for goal achievement. Raise your awareness about what you have learned about yourself as you prepare your plan to tackle your debt.

Evaluate Attitude and Human Tendencies

Each of us brings along, often times right from childhood, long-standing beliefs and opinions that will color our perceptions and our relationship with money. This can distort our sense of reality.

Before jumping into prioritizing which debt to pay off first, you must develop the habit of making regular on-time debt payments. Some debts can be paid off quickly just by eliminating late fees.

Evaluate your current income. Is my income stable? How much of my income will I contribute to achieving my goal? Do I need more income? Should I spend Less?

What are my options? 

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Image by Geralt

If you are out of options, just come up with more.

List as many alternatives courses of action as possible. Consequently, the quantity of options is more important than the quality and feasibility of each one.

Related Link: How To Make Hard Money Decision The Right Way

Maximizing choices

Create a random drawing of your debts and list each debt chronologically to determine the payoff order. Do this several times to create options. Study the feasibility and quality of each drawing or create your own feasibility study.

This is a brain-stimulating process of gathering all the options that are as valuable as the options list itself. This exercise gets my creative juices flowing. All of your options, however apparently silly, need to be evaluated. Have some fun creating your options list.

Negative assumption

Do not allow yourself to sink into bad assumptions about your options. It is easy to tell yourself:

  • It can’t be done
  • It can’t be done like that
  • I need extra money to do this
  • It will take too long

Note that all of these thoughts contain a negative. Ask yourself what if there were no obstacles, what would I do then?

Prioritizing debt by interest rate

Paying off debts with the highest interest rates first could save you the most money in the long run, assuming you pay them on time and follow other loan or cardholder agreement rules.

Both loans and credit cards can keep you in debt for many, many years if you don’t pay them off quickly. It’s easy to be overwhelmed by both of them if you only make the minimum payments.

Ranking and repaying debts in order from highest to lowest interest rate lets you put more of your payment toward principal, which can help reduce your overall debt.

One aspect of prioritizing by interest rates that you'll want to consider is your need to feel as if you're making headway.

Prioritizing debt by balance

Prioritizing by interest can help save you the most money, but if your highest–interest debt is also your largest debt, paying that off first may not give you the mental rush you need to keep going. That's because it could take longer to feel like you're making progress, and if you're beginning a long journey to debt freedom, it's crucial to stay motivated.

The payment snowball method can help keep you motivated because it lets you tackle the smallest debts first. Once those are paid off, it frees up more money to roll over into paying off bigger debts.

You should give yourself green stars as you go. You can actually track your debt as it quickly decreases. Consequently, the momentum you need to really conquer the larger debts increases more and more.

For Carlos, who used this approach, having that sense of accomplishment was important. Nevertheless, you may end up paying more in interest with this method.

Prioritizing debt by credit card minimum payment

If cash flow is your problem, create an option that offers greater budget flexibility to help you avoid racking up more debt during your pay off plan. Consider focusing on balances that have the highest minimum payment.

For instance, if your largest minimum payment is $240, by paying off that loan first, you are freeing up discretionary income to put toward other debt.

The drawback to this method is, it may not save you the most in interest payments.

I took advantage of credit cards with balance transfer promotional offers. Balance transfer offers may include credit cards with low promotional interest rates or even temporary periods of no–interest on the balance transfer amount. As a result, I rolled over debt from my high–interest credit. Credit card companies usually charge a fee on the amount transferred to promotional offers.

What Will You Do?

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Now, you know how to construct an action plan to meet your goals that have been clearly specified. Whichever of these techniques works best for you and motivates you to keep pushing forward is what you should do.

There's not one answer as to which one is best. It is time to follow through.

Write your answer to these questions

  • When will I start?
  • How will my actions serve my goal?
  • How committed am I to these actions, on a scale of 1-10?

Take the following Action

  • Set-up Accountability Measures -start by keeping track of debts, interest rates, and payments.
  • Follow-up and Feedback – review how things are going and continue learning about your money habits.

Three things to remember:

  • Always pay your credit card bill and loans on time, since late payment fees will increase the cost of borrowing.
  • Any kind of debt is still debt in the end.
  • You do not want to be shackled by debt for the rest of your life.

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