How To Know Which Debt To Pay Off First

Paying off your debt is a great way to improve your financial situation, but  if you’re juggling multiple debts, you may wonder which debt to pay off first. Whether it’s credit card debt or car loans, choosing the right debt to pay first depends on a few factors.

Let's explore these factors and some debt payoff strategies you might consider.

3 Factors In Deciding Which Debt To Pay First

If you want to pay your debt off fast or save the most in interest over time, you’ll need to decide which debt to work on first. Whichever debt you decide, you’ll continue making at least the minimum payments across all your debts, with an extra payment to the debt of your choosing.

Many factors come into play when building an accelerated debt management plan. For one, you’ll likely want to consider your different types of debt and minimum monthly payments. For example, it’s generally beneficial to pay off higher interest debts, like credit cards, first if your goal is to save money in interest over time.

Let’s take a closer look at the top conditions to keep in mind while mapping out your pathway to being debt-free.

1. Interest Rates

The interest rate attached to your debt has a big impact on how much the loan will cost you. Higher interest rates lead to paying more total interest on any balance you carry. Prioritizing the debt with the highest interest rate is usually most efficient.

As you make extra payments on your highest interest debt while still making minimum payments across all your debts, you’ll likely pay off the highest interest debt first. After that debt is paid off, you’ll apply your previous payment from that debt to the next highest-interest debt. This is known as the “avalanche method” and will save you the most in interest over time.

In general, credit cards tend to have the highest interest charges, but you could have other high-interest debt, like payday loans or auto loans. Check your loan and cardholder agreements to find the interest rate on each balance.

2. The Size Of The Debt

Some financial experts recommend paying off your debt based on its size. The idea is to pay off the smallest balance first to cut a minimum monthly payment from your budget and provide a “quick win.” As you get rid of these smaller payments, you put the extra money toward your next lowest balance. This is called the “snowball method.”

3. Type Of Debt

In addition to your interest rate, the types of debt you have may also impact your decision of which one to pay down first. For example, while some experts suggest paying off any debt as soon as possible student loans, for example, can impact your tax burden..

Perhaps more importantly,  federal student loan borrowers should also consider the various federal benefits they may be eligible for before accelerating their debt paydown, included but not limited to income-driven repayment and potential loan forgiveness. Depending on the type of loan and the sector you work in, you might qualify for loan forgiveness opportunities, which would save you from paying back the loan yourself. While the forgiven loan balance might come with a tax obligation, it could be worth the trade-off as opposed to paying off the balance yourself.

Debt Repayment Strategies

Remember, not every debt paydown method will work for every financial situation, so finding what works for you is important. Below are some of the more effective strategies when it comes to paying down your debt quickly.

Debt Avalanche Method

The debt avalanche method involves paying off your highest-interest debt first. With this strategy, you’ll put any extra funds toward this debt on top of making your minimum payments.

Once you pay it off, you begin paying the debt with the next highest interest rate. The process continues until you pay off all your debts.

Debt Snowball Method

The debt snowball method involves paying off debt with the smallest balance first. When you pay down your smallest debt, you can use the funds from that payment toward your next smallest debt.

With this strategy, the “snowball” is the money you used to pay your smaller balances. The goal is to grow your snowball to tackle your larger debts.

Debt Refinancing

Debt refinancing replaces one or several outstanding debts with a lower interest loan. Ideally, you’ll also be able to lock in a lower interest rate with the new loan, which likely will result in a lower monthly payment.

Debt refinancing works best for private loans, or when using a new loan to pay off existing credit card debt. If you have federal student loans, it is generally not recommended to refinance because of the federal loan benefits you would lose through a private lender. Depending on your loan type, refinancing your student loans could still be a good option for you.

Balance Transfer

A balance transfer involves moving debt from one or many credit cards to a new card with a lower interest rate. The goal is to avoid the cost of higher interest charges.

Balance transfer credit card deals generally have a limited window of lower rates ranging from 16 – 21 months. For example, some card issuers offer introductory 0% annual percentage rates (APR) periods. This period gives you an opportunity to make big progress toward paying off your debt.

FAQs: Which Loan To Pay Off First

Still have questions about paying off your debt? We have answers.

Is it better to pay off the smallest debt or highest interest?

Paying off your highest-interest debt first can be more mathematically efficient and save you the most in interest over time. It helps you accrue less interest overall. But paying off the smallest debt first comes with small wins which could motivate you to stick to your plan.

What debt is most important to pay off first?

For some, paying off credit card debt first is most important since it tends to have the highest interest.

Should I pay revolving credit or installment credit accounts first?

Paying off your revolving credit debts can have a positive impact on your credit score. With that, paying off your revolving debts first makes sense for many borrowers.

The Bottom Line: Put Some Thought Into Deciding Which Debt To Pay Off First

Paying off your debts, while a lengthy process, can also be exciting. Not only can it lower your stress levels and leave you with more money on hand, but it can also make getting approved for future financing easier. Remember, before taking on any new debt, building out a repayment strategy in advance can help you meet your goals.

Keeping a careful eye on your debts can prevent you from falling into financial problems. Download the Rocket Money℠ app so you can track what you owe in one place.