It can be an intimidating four-letter word: Debt.
And if you’re juggling different types — say credit card, student loan and auto loan debt — it can be hard to prioritize how to pay off that debt.
Not sure where to begin? Below are a few steps to help you identify which debts should take priority on your pay-off list.
1. CREATE A LIST OF ALL YOUR DEBTS
Before you go and say spreadsheets aren’t your thing, consider this: You can’t prioritize debt until you know how much you owe and to whom. So start a list of all your lenders and creditors, along with the below information.
- Creditor/lender name and contact information
- Type of debt (credit card, student loan, mortgage, personal loan, etc.)
- Total balance owed
- Interest rate
- Due date
- Minimum payment
- How long it would take to pay off the debt at the current payment (you might find this info on your billing statements)
- Potential benefits (like mortgage or student loan interest you may be able to deduct on taxes)
2. IDENTIFY OPPORTUNITIES TO LOWER YOUR INTEREST RATES
Now that you’ve got a bird’s-eye view of everything you owe in one place, do a scan and see whether you might be able to knock down what you pay in interest. Some of your loans might have a fixed rate you can’t negotiate, but you may be able to lower the annual percentage rate (APR) on your credit cards, for example, simply by calling and asking (particularly if you have a good credit score).
You may also be able to lower interest rates by transferring your credit card balances to a card with a lower APR, or refinancing some of your loans. But in cases like these, you’d have to weigh whether any balance-transfer or refinancing fees would be worth it. (And don’t forget that those 0 percent introductory APRs don’t last forever!)
If you’re thinking of consolidating or refinancing any federal student loans, you may end up losing some of their inherent benefits, like income-based payments or public loan forgiveness, so weigh your options carefully.
3. WHAT ADDITIONAL MONEY CAN YOU PUT TOWARD YOUR DEBT?
This will involve taking a look at your current budget and figuring out how much more of your take-home pay you can comfortably put toward debt without shortchanging important goals like your retirement contributions or emergency savings. If you want to free up more money for paying down debts, you could also take a look at your expenses and see what you can trim that can then be re-routed to your debt payments.
4. START WITH YOUR HIGH-INTEREST DEBT
After you’ve updated any interest rates that you were able to lower, sort your debt list with the highest interest rate on top. It typically makes the most sense to focus your pay-off efforts on the highest interest rate debt first, because those balances are costing you the most money to maintain. Most high-interest debt will likely be associated with credit cards.
You still need to pay at least the minimum amount due on all your other debts, so put those bills on autopay. But any extra payment you make should go toward that highest interest rate debt first. Then when you’ve paid off that debt, take the dollars you were putting toward it and apply it to the next highest interest rate loan or line of credit you have, and so on. (A strategy also known as the “avalanche method.”)
Once you’re done tackling your highest interest rate debts, you may find you have debts that hover around the same interest rate. If that’s the case, tackle the ones that don’t offer you any potential tax breaks next — for instance, a personal or auto loan over a student loan. Among those, prioritize the ones with the lowest balances because they’ll be faster to knock out.
A note about mortgages: Your mortgage debt is considered “good” debt because your home is an investment that helps build your net worth; plus, it can help you get tax breaks. So in many cases, a mortgage would be one of the last things you try to accelerate payment on.
5. KEEP YOUR DEBT IN CHECK
Think: What might have led to the debt in the first place? Was it overspending? Unexpected expenses? Get to the root of the issue so you know how to help solve it. For instance, if you just can’t seem to live within your means, it may be time to revisit your expenses and commit to sticking to a budget. If it was a leaky roof, then it might be time to beef up your emergency fund so you don’t have to resort to credit cards in a jam.
After all, you’re doing the hard work of paying down debt — so it’s important to know how not to build it back up again.