How Can I Prioritize My Debt Payments?
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Carrying multiple debts at one time is often overwhelming, and it can be difficult to figure out where to focus your repayment efforts first. Plus, the longer you keep your debts open the more you end up paying in interest over time, only compounding the problem.
It's important to find a debt repayment strategy that works for you and your unique financial situation. That way, you know exactly where to channel your payments so that they'll make the biggest impact on what you owe.
When deciding which debts to knock out first, there are two main methods you can try: The highest-interest-first plan and the snowball plan.
The highest-interest-first plan
Debts with a higher interest rate generally cost you more money in the long run than debts with lower interest rates, even if the amount of principal you owe (your balance before adding any interest) is the same. For example, if you have a $10,000 auto loan to be paid over five years, with an interest rate of 4 percent, you'll end up paying $11,049.91 in total. The same loan paid over the same amount of time, but with a 6 percent interest rate, will cost you $11,599.68 – an increase of more than $500. Paying off your debts with the highest interest rate first can help reduce your total cost over time.
If you decide to follow the highest-interest-rate plan, list your debts by interest rate from highest to lowest. Keep paying at least the minimum amount owed on all of them, but focus any extra money you can spare on the debt with the highest interest rate. After you've paid off that balance, tackle the one with the next highest interest rate, then the next, until you've taken care of all of the debts on your plate.
The debt snowball plan
An alternative debt repayment option is the snowball plan. According to this strategy, you always continue making all minimum monthly payments, but rather than organizing debts by their interest rates, you focus your extra money on eliminating the smallest balance first. Once you've paid off that one, take the amount of money you were paying each month and apply it toward the next-smallest balance, along with the minimum payments you were already making on that account.
Once the second debt is gone, you once again take all of the money you were paying each month and put it toward the next-smallest debt, continuing onward through all of the debts you owe, building momentum like a snowball rolling downhill.
Other considerations when paying off debt
Prioritizing your debt payments in relation to one another is important, but you also need to consider them in the context of your other expenses. Remember that before you focus on becoming debt-free, it's important to ensure that your basic living expenses are covered and you aren't breaking your monthly budget while you work on repayment.