Paying off debt is a worthy goal, and doing it in a timely manner matters.
However, once you decide that you are ready to start paying off debt, you have more decisions to make: Which debt should be paid off first?
The way you order your debts can have an impact on how much interest you ultimately pay, as well as how quickly you get out of debt. Here are some factors to consider when deciding how to order your debt pay-off schedule:
One of the biggest considerations in ordering your debt is the interest rate. High-interest rate debt costs more money over time as you pay for the privilege of borrowing the money. Trent Hamm, the well known personal finance blogger at The Simple Dollar, points out that high-interest debt should be tackled first: “[L]ist all of your remaining debts in order of interest rate, with the highest rate first. Then throw everything you can at the highest interest rate debt,” he writes.
By getting rid of the debt with the highest interest rate first, you are reducing the biggest money waster. You can move on to the lower interest debt (which is harming you at a slower rate) when you have eliminated the high interest debt.
Another consideration in your debt pay-off plan is whether or not the interest rate is variable. A variable interest rate can change on you with no warning, suddenly heading higher and costing you more. Fixed-rate debt, on the other hand, normally has a limited term; you also know exactly how much is going to interest from month to month. It is usually a good idea to pay off variable rate debt before attacking fixed rate debt. Eliminate the uncertainty first.
“Generally speaking, you’ll want to focus in on your unsecured debts first. These are debts like credit card debt, medical bills, personal loans, payday loans and unsubsidized student loans. All these debts usually have high interest rates because they have no assets (or security) attached to them,” blogger Prime Time Money writes.
While you want to make sure you are paying the minimum on your secured loans, any extra debt pay down money should be getting rid of unsecured debt first. Unsecured consumer debt represents items that you have likely already used, but are still paying off. It can be a morale booster to finally be out from under this type of debt.
Tax Benefits of Some Debt
A final consideration includes some of the offsetting factors available for some debt. Mortgage loans and some federal student loans come with a tax deduction for the interest you pay. While you do not want to hold onto debt longer than necessary, it is worth remembering that tax benefits make some debts cheaper than others. You want to pay off your most expensive debts first.
Sample Debt Repayment Order
In the end, you want to consider the best way to pay off the costliest debts first. Here is an example of the order you should consider when paying off your debts:
- Payday and title loans
- Credit card debt
- Personal loans from your bank or credit union
- Car loans
- Unsubsidized student loans
- Home equity loans and lines of credit
- Subsidized student loans
- First home mortgage loan
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