Managing multiple debts can be an overwhelming task, especially considering each debt has its own interest rate, due date and payment terms. But determining which debt to pay off first can save money in the long run and reduce financial stress.
To help you out, we’ve created this guide to walk you through the criteria to consider when evaluating a repayment plan for household debt and to help you explore different debt solutions.
What's in this article?
Ultimately, finding out which debt to pay off first and how to become debt free can relieve that weight from your shoulders.
Assess your debts
Interest rates
One of the most important factors to consider is the interest rate on each debt.
High-interest debts—unpaid credit card balances, for instance—can quickly accumulate more interest if left unpaid.
Prioritizing these debts can save you a significant amount of money over time.
Balance Size
Check the size of each debt balance to give yourself a clearer picture of where you stand.
Some choose to begin paying off lower balances first, a strategy that can provide psychological benefits and which offers both a sense of accomplishment and the motivation to tackle larger debts.
Minimum payments
While you’re paying off all debts, make sure to meet the minimum payments at the very least.
Failing to meet these minimum payments will likely lead to penalties, increased interest rates and can damage your credit score.
Loan terms
Consider the terms of each loan, including repayment periods and any penalties for early repayment.
Longer-term loans with lower interest rates may not need to be prioritized as highly as short-term, high-interest loans.
Type of debt
Different types of debt can have varying impacts on your financial health:
- Secured debts such as mortgages and auto loans are tied to collateral property, meaning that defaulting on these could result in the loss of your home or car.
- Unsecured debts, including credit cards and personal loans, should be carefully managed to avoid high-interest costs but might not carry the same immediate risk to your assets.
Tax considerations
Student loans, mortgages and similar debts may offer tax benefits.
Interest paid on these loans can sometimes be deducted from your taxable income, making them slightly less burdensome.
Consider these benefits when prioritizing which debts to pay off.
Emotional stress
Research has shown the negative effects of debt on your physical and mental health.
If a particular debt is causing you considerable anxiety, it might be worth prioritizing its repayment to alleviate that stress.
Ready To Take Your Next Step?
Strategize to pay off the debt
Avalanche method
The avalanche method involves prioritizing the repayment of debts with the highest interest rates first. Meanwhile, you make minimum payments on others.
Once the highest-interest debt is paid off, move to the next highest and so on, continuing this process until all debts are cleared.
This method is frequently used to minimize the amount of interest paid over time.
Snowball method
Regardless of interest rates, some folks prefer focusing on paying off the smallest debts first.
The ‘snowballing’ approach provides quick wins and can boost a person’s motivation to continue paying off debts.
Once your smaller debt is paid off, apply that payment to the next smallest debt.
Hybrid method
A hybrid approach combines both avalanche and snowball methods.
For example, you might start with the snowball method to gain momentum and then switch to the avalanche method to save on interest costs.
Consolidate debt
Finally, let’s explore one of the most popular methods of debt resolution which entirely bypasses the whole question of which debt to pay off first.
The benefits of debt consolidation
Debt consolidation can be a highly effective strategy for managing multiple debts.
It involves bringing together several debts into a single loan. If you secure a lower interest rate and a more manageable repayment schedule, the benefits can be maximized.
This approach simplifies your financial situation by reducing the number of payments you need to make each month.
Simplified payments
Consolidating your debts means you only have one monthly payment to manage, which reduces the risk of missing payments and incurring late fees.
A simplification like this can make budgeting and financial planning easier.
Potential lower interest rates
Securing a lower interest rate for your consolidation loan compared to your existing debts means you can save money on interest over the life of the loan.
+This can be particularly beneficial if you have high-interest debts like credit card balances.
Improved credit score
On-time, consistent payments on a consolidation loan can improve your credit score over time.
Additionally, reducing the number of open accounts with balances can positively impact your credit utilization ratio.
Using home equity loans for debt consolidation
A home equity loan is one potential pathway for consolidating debt by leveraging your home’s value.
Home equity loans allow you to borrow against the equity you have built up in your home, often at a lower interest rate than other types of loans.
Lower interest rates
A home equity loan offers the potential of a significantly lower interest rate, especially compared to credit cards and personal loans. A lower interest rate can result in significant savings on interest payments over time.
Fixed repayment terms
Fixed interest rates and repayment terms are common features of home equity loans.
These aspects often provide stability and predictability for monthly payments, making budgeting and future financial planning easier.
Consider the risks and make an informed decision
While home equity loans offer many benefits, they also come with risks.
Your home serves as collateral, meaning you could lose your home if you fail to make payments. It’s essential to ensure that you can comfortably manage the new loan payments before proceeding with this option.
Which debt do you pay off first? The bottom line
Knowing which debt to pay off first involves evaluating several factors, including interest rates, balance sizes, minimum payments, loan terms and the type of debt.
A home equity loan debt consolidation plan can simplify your financial situation, combining multiple debts into a single loan with potentially lower interest rates and fixed repayment terms.
However, weighing the benefits and risks carefully is paramount. Consider consulting a financial advisor to determine the best approach for your financial snapshot.
Compass Mortgage knows home equity solutions
By understanding the criteria for prioritizing debt repayment and exploring consolidation options, you can work towards a debt-free future.
Reach out to Compass Mortgage with your debt situation, and we can explore if a home equity loan is right for your debt solution.