Congratulations! You’ve decided to get proactive about paying down your debt. But where do you begin? That is, how do you decide what to pay off first?
It can be hard get better with money until you know exactly what you owe. So start by taking inventory of your debt. Make a list of your creditors, and next to each one write down your monthly minimum payment and the respective interest rate.
Once you’ve got the information on each of your loans, identify which one you’re going to focus on first. When we talk about choosing which debt to pay down first, remember to factor in the monthly minimum payment on all of your debts. The debt you choose to pay down first is simply the one to which you designate any additional money above and beyond your minimum payments.
Maintaining minimum payments on all of your debts is critical as it can help you avoid late or missed payments and help keep your credit in good health. So if you can afford to pay anything over and above the minimum on your debts, it’s a good idea to do just that. There are two popular payoff strategies for doing so: the debt snowball and the debt avalanche.
The debt snowball strategy
When using the debt snowball strategy, you contribute anything above and beyond your monthly minimum payments toward the debt with the lowest balance first. Once that debt is paid off, you don’t reduce the amount you put towards your debt pay-off each month. Instead, you put the total force of your debt repayment efforts towards your remaining minimum payments and the debt with the next lowest balance, gathering momentum as you pay off each small debt.
The debt avalanche strategy
An alternative debt repayment strategy is the debt avalanche, in which you pay the minimum on all of your debts each month, but you put anything over and above the minimum toward the debt with the highest interest rate first. Once you’ve eliminated that debt, you focus on the debt with the next highest interest rate, then the next and the next until you get all of your balances down to zero.
Choosing your strategy and what to pay off first
Now back to the question at hand: which debt should you pay off first? This may vary depending on individual circumstances but might also come down to what works best for you, and not just in a financial sense.
When tackling the debt with the lowest balance first, as you do in the debt snowball, you could get the psychological boost of progress and momentum when that smallest debt gets paid off, keeping you motivated through the remainder of the debt repayment process.
The debt avalanche, however, may be the more cost-effective strategy because you tackle the debt with the highest interest rate first, and the higher the interest rate, which is the more expensive debt over time. So when you pay off debts with high interest rates first, you could end up saving money in the long run.
While the debt avalanche may be a more cost-effective strategy, managing money isn’t just about what’s cost-effective. Money can be emotional, psychological and stressful. Especially when financial emergencies and other unexpected events take place. So you might be more motivated to pay down your debt if you get an early momentum boost by eliminating a small debt early on.
In the end, as long as you’re making more than the minimum payments on your debts, you’re moving in the right direction. So don’t get stressed out or stuck on picking a strategy. Just pick one and stick to it. Every time you send in an on-time payment, every time you pay more than the minimum, every time you take a step towards building your net worth, that’s a win. Celebrate it!
The key is to implement the strategy that works best for you. Whichever one you choose, remember that consolidating your debt can be a good way to get started.