One of the questions that many consumers ask as they wrestle with the realities of debt repayment is which debt to tackle first.
There are different schools of thought, with some insisting that you start with the debt that has the lowest balance, and others insisting that you rank your debts in order of highest interest rate to lowest interest rate.
Both of these approaches have their benefits and drawbacks. One thing you might try, though, is to group your debts according to category, and then pay them off in a way that makes sense to you within those categories.
Here are some categories to think of when paying down debt:
High Interest Consumer Debt
No matter how you order your debts, this is the type of debt you should target first. Divide out your credit card debt and pay day loan debt from other types of debt. This category of debt is the most dangerous to your long-term financial health, and your efforts to become financially free. As a result, it makes sense to tackle it first.
Identify your credit card debts and pay day loans, and then order them in whatever way makes sense to you, whether you start with the smallest balance, or whether you decide to start with the highest interest rate.
Low Interest, Tax-Deductible Debt
Next, identify your low interest debt. There are debts that not only have low interest rates, but are also tax-deductible. Home loans, business loans, and student loans all come with tax advantages, and they are often also low-rate. These loans should be saved for last. Not only is there a chance that you could make investments that offset the low interest rates, but the effects of the interest costs are offset to some degree by the tax deductions you receive on the interest you pay.
Make sure this debt is saved for last. And, if you are able to see an average annual return that beats your interest payments, it’s worth considering putting the extra money toward investments, rather than paying down this low interest debt.
There are other debts that you might have. Some of these debts include auto loans, P2P loans, non-deductible lines of credit, and loans from friends and family. Often, these interest rates fall somewhere between high-rate consumer debt and low-rate debt. Tackle this type of debt in the middle of your plan. If you are concerned about your standing with a friend or relative, interest rate and amount of the debt may not matter. Instead, it might make sense to just approach the debt and discharge it quickly to spare your relationship.
After you have paid off your high-rate consumer debt, set your sights on these types of debt. Once again, you can order your debts in a way that works for you; the important thing is to make progress and pay off your debt in a way that allows you to fix your underlying money problems as you go along.
Don’t forget, throughout this process, to keep making all of your minimum payments. These categories should be used as a guide to help you decide where to put extra debt pay down efforts. Unless you are attempting debt settlement, you want to make sure that all your minimums are made on time and in full.