Which debt should you pay off first?

We’ve all been there. Borrowing from Peter to pay Paul. Then borrowing from Mary to pay Peter. Before you know it you’re up to your neck in debt and struggling to stay afloat. If this is you, don’t beat yourself up. You’re not alone. A lot of people struggle to repay their debt. If things have been difficult for you with your debts, you might find that following a proven debt payoff strategy is just the thing you need to become debt-free. This article covers a few different methods to pay off debt and other things to be mindful of when you’re getting strategic about becoming debt-free.

The debt avalanche method: Pay off loans with the highest interest rates first.

You may have heard about the debt avalanche method if you’ve looked into debt consolidation, debt repayment, or debt relief. The debt avalanche method is an effective debt repayment strategy that results in you paying the least amount of interest over time, saving you a lot of money.

Want to try this method? First, gather all the statements and information you have on your debts. Include high-interest credit cards, car loans, installment loans, and consolidation loans or balance transfer credit cards if you have them. Look at the interest rate for each one, then order these debts by interest rate from highest to lowest.

You can find the interest rate and other important information on your monthly statement, the online banking portal for the account, or you can call your lender. Once you have your debts arranged by interest rate, start the debt avalanche by paying a little more each month on your highest-interest debt. You’ll still want to make your minimum monthly payments on all your other debts, including debts with lower interest rates like your mortgage, a home equity line of credit, or student loans. Continuing to make minimum payments on your loans will keep you in good standing with your lenders and help protect your credit score. 

Once you’ve paid off your debt with the highest interest, you can start using the extra money in your budget to pay down the next highest-interest debt you have. You may even have a little extra to put toward it since you’ve knocked out one debt. Soon enough you’ll have done some serious debt repayment without going to another lender for a personal loan or consolidation loan. 

To be successful with the debt avalanche method you’ll need some serious motivation and a long-term perspective. This may not be the right strategy for everyone. Luckily, there’s another method that allows you to get quick wins and build momentum with your debt repayment: the debt snowball method.

The debt snowball method: Pay off your smallest debts first.

Since paying off debt can be challenging, building momentum with quick wins can help you stay motivated to keep going. Some research shows that the debt snowball method is effective because of this psychological boost. 

To use the debt snowball method, look at the total amount you owe on each debt. Make the minimum payments on all your debts except on your lowest debt. Pay extra on that debt each month until it’s paid off. Then move on to the next one. For example, let’s say you’re working on repaying the following debts:

• $2,000 on a high-interest credit card 

• $6,500 on a balance transfer credit 

• $30,000 on a car loan

With the debt snowball method, you’d start by putting extra money toward the $2,000 credit card.

One advantage of this method is that as you pay off accounts, you won’t have to keep track of as many loans. This is helpful, especially when cash is tight. The downside is that you’ll end up paying more in interest over time. 

When it comes to choosing a method, you know yourself best. If you’ll be motivated to stick to your budget no matter what, the debt avalanche method may be better for you. If you need help staying motivated, the snowball method might work best.

Possible Exceptions

Everyone’s budget and personal finances are unique. There isn’t a single plan that is right for everyone. There are also certain kinds of debt, like accounts with deferred interest or high annual fees, that you might want to prioritize even if other debts have a similar or lower interest rate. You’ll have to weigh the pros and cons and make a judgment call.

Credit Cards or Loans With Deferred Interest

Most people have heard of credit cards or loans with low or no interest promotional rates. After the promotional period is up, interest begins to accrue. Some credit cards or loans offer a similar promotional period but with a hidden surprise: deferred interest.

If you get a card or loan with deferred interest, you won’t have to pay interest during the promotional period. But if you don’t pay off the balance by the end of the promotional period, you’ll be responsible for paying all the accumulated interest. Even if you only have a small amount of the loan left to pay, you’ll be stuck paying the interest that has added up during the 0% interest period. 

Not all loans with introductory APRs or promotional periods have deferred interest. But since some do and the consequences can be serious, you’ll want to check the terms and conditions on your loan statement or credit card statement or speak with your issuers to find out. Deferred interest is most common with installment loans or credit cards that are tied to certain stores such as furniture stores, home improvement stores, or medical loans. 

For example, say you decide to replace a few appliances for the total price of $3,000. You decide to pay for this by opening a store credit card with deferred interest. By the next month, you have paid $1,200 off because you worked a little bit of overtime and used part of your pandemic relief payments. Then you plan to slowly pay the rest off as things get tighter financially. If you haven’t paid the balance off in full by the end of the promotional period, you’ll end up paying interest on the full $3,000 you initially borrowed rather than just paying interest on the remaining $1,800 balance. 

Make sure that you know when the promo period ends. It doesn’t always line up nicely with your statement date or your normal due date. Since a lot of interest accumulates all at once, pay these types of debts off as soon as you can. If you are using the debt avalanche method, use the go-to interest rate for this debt, not the promotional interest rate, when determining what order to pay down your debts.

Credit Cards or Loans With High Annual Fees

Remember that when you are dealing with credit cards and loans there are two types of costs: interest and fees. It can be a relief to pay off and close a card with a high annual fee, especially if the card doesn’t have benefits that make the fee worth it. Many people are traveling less, so perhaps it is a good time to think about closing your travel rewards credit card if it has a ridiculous annual fee. It’s not worth paying thousands of dollars to get a few mileage points. Or maybe you can find another card that offers benefits and doesn’t charge an annual fee.

If you’re good with math, you can figure out whether you will save more money by paying off a high-APR loan or a card with a high annual fee first. If you’re not sure, look at your monthly loan or credit card statements and compare the interest you’re paying to the fees.

Always make sure you make minimum payments.

No matter which debts you tackle first and no matter what method you use, make sure you set aside enough money to make the minimum payments on time for each of your loans, credit cards, and other debts. With credit cards and other types of revolving credit, the minimum monthly payment can vary month to month. Keep up with it and stay the course.

By avoiding late fees and missed payments you will save money and have less stress. Missed payments will show up on your credit report and hurt your credit score. Having poor credit will make it more difficult for you to get a personal loan or a consolidation loan if you find yourself struggling financially. 

Strategies if You’re Having Trouble Making Ends Meet

When you’re having trouble making ends meet you need to get even more focused and strategic with your debt repayment. Think about focusing on repaying secured debts. It’s important to stay current with secured debt, like a car loan. That’s because secured debt is backed by property, which can be repossessed (a car) or foreclosed on (a home) if you are in default. Losing your car or home can create even more financial difficulty.

Another tactic to think about when you’re having trouble making ends meet is paying off debts that can’t be easily discharged in bankruptcy, like student loans. Student loans are almost never discharged in bankruptcy. To be discharged, they have to create a significant undue hardship on the debtor. This level of hardship is extremely difficult to prove.

If you’re having a hard time paying off unsecured debt like credit cards, bankruptcy could be a good option for you. You can see if you’re a good candidate for bankruptcy by using Upsolve’s screener, which helps you file for bankruptcy for free.

Let’s Summarize...

Getting debt relief and becoming debt-free are beautiful things. It can be tough though. Developing a game plan and sticking to your financial strategy will be rewarding in the end for you. If you are highly motivated to save as much money as possible, use the debt avalanche method and start by paying down your highest interest rate loans or cards first. If you think you’ll need extra motivation to pay down debt, have a hard time sticking to a plan, or need to see some victories first, consider using the debt snowball method and start by paying off your smallest debts first.

If you are having a difficult time getting started or figuring out a doable payment plan, consider working with a nonprofit credit counseling agency. They can help alleviate the confusion about personal finance, debt repayment, and budgeting strategies.