The average American has $38,000 in personal debt, according to a 2018 study by Northwestern Mutual, and that’s not including home mortgages. That number is made up by credit cards, student loans, car notes, and more.
If you have multiple types of debt you want to pay off, it can be tough to know where to start. Without a clear plan and priorities, however, your progress can be slow, making it difficult to stay motivated.
To help you know which loans to pay off first, it’s important to know where you stand, choose a repayment strategy, and understand which debts to target first. Here’s how to get started.
First, List Your Debts
Before you do anything, it’s essential to take stock of your debts and start thinking about which ones you want to pay off first.
Start by creating a spreadsheet that includes:
- The amount of each debt
- Interest rates
- Credit limits (credit cards and lines of credits)
- Loan terms
Next, add another column to your spreadsheet noting whether each debt is considered good debt vs. bad debt. In general, consumer debt with high interest rates and no tax benefits are considered bad debt, as are debts that are placing a heavy burden on your financial wellness.
On the flip side, good debts are typically low-interest and can be used to improve your financial well-being. We’ll get into details a little more about some specific debts and when you should target them.
Next, Choose a Repayment Strategy
There’s no single best way to decide which loans to pay off first. There are three general methods you can use, depending on your situation and your preferences.
Pay Off Debts With the Lowest Balances
Also called the debt snowball method, this strategy involves focusing on paying off your debt with the smallest balance first. Once you’ve eliminated the debt, take its monthly payment and apply it to the debt with the next smallest balance until it’s paid off, then keep doing the same until all your debts are paid off.
Benefits of choosing this approach:
- Paying off smaller balances quickly allows you to celebrate small and frequent wins.
- It’s easy to maintain momentum when you see fast results.
Pay Off Debts With the Highest Interest Rates
This strategy is often called the debt avalanche method and targets high-interest debts first, regardless of how big or small the balance. The process of rolling payments from paid off debts into the next debt, however, remains the same.
Benefits of choosing this approach:
- You’ll save more money in the long run by eliminating high-interest debts first.
- You may sleep better at night once your bad debts are gone.
Pay Off Debts Ordered By Credit Limit
If you have a lot of credit cards with balances, this method prioritizes the accounts where you’re closest to the card’s credit limit. Your credit utilization, which is a card’s balance divided by its credit limit, is an important factor in your credit score.
Once you’ve eliminated your credit card debt, you can use one of the other methods to prioritize your remaining debts.
Benefits of choosing this approach:
- Lowering your credit utilization can boost your credit score.
- Eliminating credit card debt first removes less-structured debt from your life.
Which Loans You Should Pay Off First
Even with a general strategy in mind, it’s not always easy to know which debts you should address first. If you’re not sure where to begin with your debt repayment strategy, here are a few examples to get you started.
Credit Card Debt: Pay Off Now
Credit card debt is particularly difficult because of its revolving nature. Unlike loans, credit cards don’t have a set repayment term. Instead, credit card companies charge you a minimum monthly payment at a small fraction of what you actually owe.
If you just make your minimum payment while paying off loans with lower interest rates, it’s easy to rack up a huge balance over time — especially if you’re still using your credit cards every month.
Mortgages: Pay Off Later
Mortgage loans typically have low interest rates because they’re secured by your home as collateral. They also typically represent the lion’s share of your overall household debt and can take years to pay off, leaving interest on more expensive debts to continue accruing.
What’s more, any interest paid on a mortgage loan of up to $750,000 is deductible as an itemized deduction when you file your taxes.
If your mortgage does represent an excessive burden on your cash flow, it may be a good idea to refinance your loan or sell your home in favor of a more affordable one.
Car Loans: Pay Off Sooner Than Later
While car loans aren’t inherently bad, interest rates can run upwards of 20% if you have bad credit. Even if you have a low interest rate, cars depreciate over time.
If the value of your car depreciates faster than you pay off the balance, you could be stuck paying the difference if you get in an accident and the car is totaled.
You’ll still want to prioritize credit card debt over a car loan, but the debt may be next on your list.
Student Loans: Pay Off Later
For many, student loan debt can feel oppressive. But with relatively low interest rates and income-driven repayment options on federal loans, they don’t pose as much of a threat as credit cards and other high-interest debt.
Plus, the IRS allows eligible student loan borrowers to deduct up to $2,500 in student loan interest paid each year.
While you don’t want student loan debt to fall off your radar completely, it makes sense to address other high-interest debts first.
Tips to Help With Debt Repayment
As you decide how to pay off your debts, there are other things you can do to help speed up the process. Depending on your credit situation and goals, here are some to consider.
Write Down Your Reasons
Paying off debt is not a fun experience, and it can be difficult to stay motivated when you’d rather be using your money for other things.
One way to keep up your momentum is to write down your reasons for wanting to be debt-free and use the list to remind yourself every once in a while.
For example, maybe you want to save for a nicer home, get a specific car model, or take a big international vacation. Whatever it is, make sure it’s something you care deeply enough about that it will keep you on the tracks when you’re starting to feel bored or discouraged.
Find Areas to Cut Back
The sooner you eliminate your debt, the sooner you’ll be able to start focusing on your other financial goals. One way to achieve that is to cut back on some discretionary spending and put that money toward your debts instead.
Don’t go overboard, though. If you try to live too frugally, you could burn out and overcorrect. Decide for yourself where it is that you’ll find a good balance between aggressively paying down debt and enjoying your lifestyle.
Look for Ways to Earn Extra Cash
Whether it’s looking up side gigs on Craigslist or starting a side hustle of your own doing something you love, earning a little extra money each month gives you more to put toward your debt.
Regardless of what you choose, don’t be afraid to explore several options to find the one that best fits your goals and preferences.
Refinance Some Debts
If your credit has improved since you first took out some of your loans, you may qualify for a lower interest rate on a refinance loan. This is more common with mortgage, car, and student loans, but you can also do it with credit cards in the form of a balance transfer credit card or consolidation loan.
Before you refinance, though, run the numbers to make sure it’ll save you money. Going for a lower monthly payment by lengthening your repayment term can end up costing you more in the long run.
The Bottom Line
It’s easy to make blanket statements about different types of debt and how you should prioritize which loans to pay off first. But ultimately, the most important thing you can do is to make a plan based on your financial situation and goals.
For example, you may decide that you’d feel better getting rid of your student loans before anything else. Or maybe the interest rates on your mortgage and car loan are low enough that you want to keep them and use your cash for other things.
Whatever you do, make sure you understand where you stand with each of your creditors and find the path that works best for you. Also, make an effort to always pay all your debts on time.
Late payments and delinquent accounts can cause a lot of damage to your credit score, which can ruin your chances of getting affordable credit in the future.