Which of my debts should I pay off first?
Have you borrowed money from all your credit accounts and you’re not sure which debt to pay off first? Maybe you financed your new business with some loans and now you have to pay back. But you’re stuck because there are a lot of debts to be paid and you don’t know where to start.
A survey by the US Chamber of Commerce reveals that Americans owe about $1 trillion in credit card debt. This money is money owed by individuals and corporate entities in the United States.
Another survey by Debt.org shows that there’s a direct relationship between the amount of money an individual owes and independent factors like their age, educational level, and family type.
If you’ve ever borrowed money from different creditors or from different credit accounts, you should know that deciding on which creditor to pay off first can be quite daunting. This usually results from limited funds, a ticking clock, and ever-increasing interest rates.
Here’s something you must know.
There’s no formula for paying off your credits. It’d have been easier if there were some laid-down rules that told you to repay the credits on Card X before you pay off those on Card A.
However, your eventual decision depends on some factors. We’re going to look at these factors and some pointers to help you make the right decision.
Factors to consider before you pick the debt to pay off first
Here are a few things you should look at before settling on which debt to pay first:
1, Secured or Unsecured Debt.
These are two of the main types of debts people get into in the United States and around the world.
A secured debt is one backed up by collateral. This implies that to access secured debt, you must present your lender with tangible material. In practice, you’re giving the collateral as a security for the money you want to borrow.
A secured debt contract allows the lender to legally repossess any asset the borrower presents as collateral if the latter defaults. Most lenders demand that you present an asset of equal or higher value than the loan amount.
A clear example is handing in your house as collateral to obtain a loan from a financial institution. If you’re unable to repay the money on the due date, the borrower could begin proceedings to recover their money by selling the house. The process of taking this house away from your legal ownership is known as repossession.
An unsecured debt, on the other hand, isn’t tied to a collateral. The lender trusts your goodwill and expects you to abide by the contract. They trust you to make repayment on or before the due date. So they don’t ask for any asset they can repossess if you’re unable to keep to your own end of the deal.
Both loan types have their advantages and disadvantages. You should put these into consideration when making a decision.
2. Interest rates
The interest rates on your debts will, to a large extent, determine which debt you’ll pay off first. Loans with a high interest rate usually take longer to pay off. This is because the interests account for a sizable part of the monthly repayment sum.
Knowing the interest rates on your credit card and other loan products, you can decide on which one to pay off first. Also, you’ll be able to tell which ones to attend to at a later time.
3. Debt strain
Let’s face it. There are some debts you owe that threaten to grab you by the neck and squeeze you to death. This may not be a result of the amount of money you owe. It may just be that owing your creditor for a long time doesn’t sit well with you.
So, it’s important to consider the amount of strain a debt causes you when making a decision. Strain, in this context, can be emotional, psychological, physical, or mental. Debts like medical loans may fall under this category. At the end of the day, it all depends on you.
Which debts should you pay off first?
For the best results, pay off your debts in this order:
- First, tick high-interest rate debts off your list. This involves taking stock of all the debts you owe and marking those with high interest rates. Focus on the one with the highest interest rate and pay it off in full.
As you do this, you can take out a little part of your earnings to pay off other debts with lower interest rates. The major advantage of this is that it helps you save more money – the money you would have paid on interests.
This method is known as the Debt Avalanche Method.
- Combine the Debt Avalanche Method with the Snowball Method of Debt Repayment. Here, focus on paying off the smallest debts you owe, regardless of the interest rates or other independent factors.
For example, if you have to pay off two debts of $1000 and $4000, you can start with the $1000, even if the $4000 has a higher interest rate.
The major advantage of this method is that it allows for focus. If you have your attention on the smallest debt, it’s easier to pay it off immediately. We all know the indescribable feeling of progress that comes with offsetting a debt.
It feels like heaven.
- First pay off debts that stress you before thinking of those that don’t put you under similar pressure. These debts could be a loan from a friend or family, a car loan, or hospital loans.
- Pay off your secured loans before offsetting unsecured loans. This eliminates the possibility of losing your valuable assets to your creditors.
Paying off your debts is a worthy task. However, to succeed, consider employing the points we’ve discussed in this article. If you’re still in doubt, this link provides more information on the links to pay off first.