If you have debt, you’ve probably asked yourself countless times how to pay it off. If you’re still asking yourself that question, then you’re in the right place. But if you have several debt accounts, how do you figure out which debt to pay off first? And how much?
Knowing where to start and how to proceed, especially when choosing which account and how much you’re paying off next can easily equate to saving hundreds, if not thousands of dollars. Making the wrong decision can definitely make the whole process much more expensive and stressful than it needs to be. Worse, it might mean giving up on ever being debt-free again.
Here’s your personalized guide to doing it right.
How to Effectively Prioritize Debt Payments
- Stop Digging Yourself Deeper
This may seem like it’s too obvious to mention, but you’d be surprised by the number of people who need to be reminded of this initial step in any debt-reduction plan. Once you decide to get yourself out of debt, stop going back into debt. Work out a budget that allows you to live within your means while making substantive payments on the money you owe. Stop using that credit card until you’ve finished paying it off! Data shows that, despite the obviousness of this advice, Americans are putting themselves more and more into debt each passing quarter.
Yes, this can be painful if you’ve been living on credit for a while. Yes, it means taking a hard look at information that might hurt your feelings. Yes, you will probably get into at least one fight with your spouse over it. No, none of those yeses mean you get to skip this step.
If you’ve been living on credit, then you’ve actually been living beyond your means. The first step toward getting yourself out of debt will obviously involve taking a serious look at your spending habits and drastically changing them in order to begin living within your means once again. In fact, you might even have to live below your means just to pay your debt off—but don’t worry, that’s just temporary. Stop digging your debt-hole deeper if you ever want to see the debt-free light at the end of the tunnel.
- Understand Each Account’s Details
To properly prioritize your debt service, you first have to avoid late fees moving forward. Late fees are like an extra interest payment at an APR of 29%, or more in many cases, and easily avoided. More than that, late payment on a credit card can have much bigger and worse consequences, from higher interest rates to legal ramifications that get worse the longer you go without paying or updating your situation with the credit card company.
Sit down and make a list of every debt account you have. We like spreadsheets for this, but anything you can use to make on-time payments moving forward is fine. List the minimum payments and the date those payments are due. Do whatever you must to make those minimum payments on time, every time—except putting yourself in more debt somewhere else by using another credit card.
Almost all creditors these days offer automatic payment options, and we recommend using that option if you struggle to track your payments and dues yourself. It automates the hassle involved in making your payments on time. The only exception is if your income fluctuates enough that the autopay could cause an overdraft, which is a whole other kind of expense you don’t need.
- Determine Your Pay-Off Strategy
Once you have your list of minimum payments totaled, you will have an amount of extra money to apply to your debt so that you can pay things down faster. But which account do you pay that money to first?
There are three ways to make this decision:
- Pay off the account with the highest interest rate first. This usually means you’ll be out of debt faster, but can mean slower apparent progress toward being debt free.
- Pay off the account with the lowest balance first. This keeps you in debt a little longer, but is psychologically satisfying and has a higher rate of success for most families.
- Pay off the account with the lowest minimum payment first. This is another gratifying method, because your extra payments are large compared to the minimum, and you see rapid and immediate progress on the balance.
Any one of these payment strategies is fine. Just pick one and stick to it for at least six months and you’ll make a real dent into your debt payments.
- Consider the Snowball Effect
Whichever prioritization method you land on, you will eventually reach a point where you pay off one of your debt accounts completely. At that point, you roll over what you’ve been paying on that account to make aggressive payments on the next account on your list. This method is called the snowball method of paying off your debt.
For example: Say you’re using the low-balance method. The minimum payment on your lowest balance account is $50 per month, and you’re putting $100 each month extra toward paying off your debt. After paying off that credit card at a rate of $150 each month for six months, you have a zero balance due on that card.
You then take that $150 each month and add it to the $80 minimum payment you’ve been making on a student loan. Your balance on that loan now drops by $230 a month—rapid progress. Once the student loan is paid off, you add $230 to the $150 car loan you pay. The amount snowballs as you go until you’re taking aim at your mortgage.
Some folks like to celebrate paying off a loan by skipping one month of aggressive payments. When you’ve killed that credit card, you take that $150 and have a nice meal out. After the student loan is done, you spend $230 to get a nice painting for your living room. The next month you get right on track, but it does help motivate you to know that there’s a nice reward for each success. This is a perfect example where you can begin to live within your means rather than below them while still paying your debt off.
- Understand Common Debt Payment Tricks
You can use the system above to be successful in prioritizing paying off your debts, but if you have the interest and discipline, you can make even faster progress by getting into the details of your credit score, payments, and cards. The variables are wide, wild, and weird, but here are a few common examples:
- Some super-low interest loans have rates lower than the rate of inflation. Always pay them off last.
- If you have a credit card or line with a 0-interest grace period, cycle through transferring balances from other accounts into it. That way you pay off more principle with each payment.
- Credit cards and other lines of credit have reducing minimum payments as the balance goes down. You can choose to reduce the payments you make (thus increasing how much you pay on your targeted account) or just make the original minimum each month and pay more of the principle.
- If you have a rewards credit card with a grace period, you can continue to make purchases you would normally make, and pay off those purchases in real time. This gets you free stuff without impacting your overall debt-reduction strategy.
- Consider getting a low-interest loan like a HELOC to pay off higher-interest accounts, but only if you know you can avoid using those cleared credit cards moving forward.
The list of possible complications is literally endless. For most people, you will make good enough progress without trying any of these trickier moves. But if you’re geeky enough (like us) to enjoy the gamification of your debt, these little things can make a difference.
You’ll notice that the “right way” to prioritize paying off your debt isn’t a universal, one-size-fits-all prescription. You’ll need to make choices based on the reality of your situation and how you are personally motivated. If you’re married, you’ll also have to adjust to where you and your partner agree, and where you are wired differently.
Ultimately, which set of choices you make isn’t important, as long as they fall within the best practices we outlined here. It only matters that your choices match your values, personality, and habits in ways that keep you on track until you’ve worked the plan to completion. Once you’ve done that, the rest is just a matter of patience and practice.
Oliver Grego is a financial consultant with an extensive background in Corporate America. After decades of paying his dues, he now offers advice to his clients about the best ways to deal with their debt, be it from student loans, a mortgage, car payments, or just bad financial behavior.