Debt payment strategies to suit your lifestyle.
If you're juggling credit cards, student loans, car loans, and mortgages, managing your debt can seem straightforward – just make minimum payments. But when it comes to paying down your debt, prioritization is key. Which debt should you focus on first? Here are some strategies to consider, each with its own advantages and drawbacks.
Pay Off the Highest Interest First
If you want to save money in the long run, paying off the debt with the highest interest rate is often the best strategy. By eliminating the most expensive debt first, you’ll reduce the total amount you pay in interest over time. However, this strategy has its challenges. For instance, your highest-interest debt may also be your largest – such as a mortgage or a student loan. As Bankrate’s Nicole Dieker points out, this can feel discouraging as you might spend years chipping away at a large debt and only be covering the interest.
Pay Off the Lowest Debt First
If you’re motivated by quick wins, paying off your smallest debts first may be the right approach. This method, known as the “debt snowball” method, can help build momentum as you check off smaller debts from your list. While you may end up paying more in interest over the life of the loan, this approach can offer a psychological boost and relieve stress from collection calls, according to Miriam Caldwell of The Balance.
Pay Off High Credit Utilization Debt
For borrowers seeking to improve their credit score, paying down high credit utilization debt should be a priority. When your credit cards are maxed out, your credit utilization ratio increases, which can lower your score. By reducing balances on high-interest cards that are close to their limit (over 30% utilization), you can boost your credit score and eventually secure better interest rates on future loans. The Motley Fool recommends focusing on this type of debt if improving your credit score is a primary goal.
Account for Tax Breaks
While paying off interest feels like a financial drain, some loans come with tax breaks. For instance, paying student loan interest may give you a tax deduction, potentially making it more beneficial to prioritize other types of debt first. As Caldwell suggests, while you shouldn’t neglect your student loans, paying off high-interest debt like credit cards could offer greater immediate financial relief.
Consider a Hybrid Approach
Everyone’s financial situation is unique, and a combination of strategies may work best for you. For example, you could start by eliminating a few small debts to build momentum and then focus on tackling higher-interest loans. For more guidance on how to prioritize your debt, consider consulting with a financial planner, family member, or spouse. You can also use our Five Star Bank managing debt calculator to get a clearer picture of how much you owe and how long it will take to pay it all off.
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