The causes of over-indebtedness are as diverse as we are. Often it happens gradually with seemingly harmless credit card charges over time. Sometimes it’s unavoidable, such as overwhelming medical debt after an accident or a layoff during hard economic times.
Other times we simply misjudge how much we can afford, and enter into a pattern of over-spending and debt accumulation.
Whatever the cause, the solution is clear – we’ve got to reduce our debt load and get back into the habit of spending within our means.
For anyone who has decided that it’s time to start paying down that debt and reclaiming your financial freedom, congratulations. But the question remains, how do you choose which debts to pay off first?
Some credit experts advise paying off high interest debts first, while others suggest tackling the ones with the smallest balance. While there is no perfect answer that will fit every financial situation, here are six steps that can help you to decide where your debt repayment dollars will have the biggest impact.
1. Figure out what you owe
The first step for anyone looking to pay off their debts is to take an inventory. Make a written list of your debts by type, the interest rate charged, the amount you owe, and if it’s a credit card, the amount available on your credit line. It may seem like a rudimentary exercise, but having all of this information together in one place can really give a clear picture of where you stand, and where you should begin paying off your debts.
Consider downloading a debt management program or app to really get a bird’s-eye-view of your outstanding debts and obligations.
2. Separate loans by type
The next step should be to separate all of your installment loan debt like mortgage and car payments from your revolving credit debt. Since most installment loans have a fixed payment period and usually come with a lower interest rate, it makes more sense to concentrate on revolving loans like credit cards and store cards. It’s those debts that you have the most control over and that can have the biggest impact on your financial picture.
“Whichever method you choose, it’s
crucial that you stick with your plan.”
3. Focus on the biggest debt you owe
Once you’ve identified your revolving credit debt, it’s time to formulate a strategy. Most credit experts agree that a concentrated or focused approach to paying down debt is best. It involves selecting a single debt to focus on paying down first, while making minimum payments on the rest.
4. Consider the “snowball method”
If you have a lot of different credit cards with varying interest rates and balances owed, one approach is to choose the card with the lowest balance amount and focus all of your resources toward paying that one off first. You should make the minimum payments on the rest until the first is paid off, and then focus on the card with the next lowest balance. This method can result in more cards being paid off sooner, and can have a positive psychological effect as a result.
This is sometimes called the snowball method of debt repayment.
5. Pay off the highest interest rate first
For folks with few cards but that carry high balances, it’s sometimes recommended that you identify the highest interest card and focus all of your resources on paying that one off first. This method has the advantage of minimizing the interest you’ll pay, however it may take longer to pay off each individual card.
6. Do the balance transfer shuffle
As an alternative to the snowball method, you could put all or some of your high-interest debt on a low-interest credit card and pay it down before the interest rate increases. This will help save you significant money in interest and can actually speed up your debt payoff.
Be careful with this method, as there are often fees for balance transfers. Be sure to calculate how much you will be charged to see if this method makes sense for you.
Whichever method you choose in prioritizing your debt repayment, it’s crucial that you stick with your plan. None of these techniques will be effective if you continue to accumulate more debt.
Consider what method will keep you on track with your debt pay-down plan, and commit to seeing it through until your debt is paid off. Once you’re successful, you may find that your spending and credit habits have changed for good.