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I get the question of “what debt should I pay off first” many times. Not just by readers, but by friends and family members as well. In general, there are two approaches you can take when paying off your debt. You just have to determine which one makes the most sense for you. Let’s look at your options in depth.
What Debt Should I Pay Off First?
Here are your two primary options for paying off debt. You can combine these and tweak them around a bit, but overall, these are the two methods most people use.
Option 1 is to pay off the highest interest rate debt first. This approach will save you the most on interest charges but it may take you longer to get out of debt.
Option 2 is to pay off the smallest debt balance first. This approach provides you motivation to stay on the path of paying off your debt. Of course, you may end up paying more in interest with this option.
Highest Interest First Option
The first option is save the most on interest charges. Let’s look at how this option works.
Let’s say you have 2 loans as seen below:
- Loan #1: $10,000 10%
- Loan #2: $15,000 20%
Following the high interest first method, you would pay the minimum balance on loan #1 and put the rest of the money you can afford to pay off your debt towards loan #2. Once loan #2 is paid off, the entire amount you have earmarked for debt repayment would go towards loan #1.
In this case, you would save the most in interest charges because you paid off the debt that was costing you the most first.
Smallest Balance First Option
The second option is to pay off the smallest debt the quickest. Let’s look at how this option works.
Again, let’s say you have 2 loans as seen below:
- Loan #1: $10,000 18%
- Loan #2: $5,000 13%
With the smallest balance first method, you would pay off loan #2 first since it has the smallest balance. You make the minimum payment to loan #1 and put the rest of the money you have set aside for debt repayment to loan #2. Once loan #2 is paid off, you will put the money you were using to pay off that loan towards loan #1.
Advantages And Disadvantages Of Each
Each method has advantages and disadvantages. With the highest interest first option (option #1) we will pay the least amount of interest in total since we are eliminating the debt with the highest interest rate first. The disadvantage to this option is that in some cases, it can take longer to pay off the debt, both in the long term and short term.
The smallest balance first option (option #2) reverses the advantages and disadvantages. Here, you will pay off some debt quicker over the short term and possibly the long term, but you will pay more in interest overall.
Therefore, you have to decide which is more important to you? Is it saving the most in interest charges or making the fastest progress on your debt repayment? For many readers, the answer is the fastest progress.
This is because we like to see immediate results. When you have credit card debt on 3 cards and get rid of the debt on one of those cards quickly, it will help you to stay motivated to keep going. This is why most should pay off the card with the smallest balance first.
Of course, speaking solely as finance guy, paying the highest interest rate debt off first is the smartest decision you can make. You save yourself hundreds, possibly thousands of dollars in interest. You may ask then why I say most should do the exact opposite. It’s because the most important thing is to simply get out of debt. That is the ultimate goal – not saving the most in interest or getting out of debt the quickest – but to just get out of debt.
As with anything in personal finance, the option you choose to get out of debt will be different than someone else’s. This is OK. You do what you need to do to get out of debt. That is the key – taking back control of your financial life. Regardless which option you choose, I encourage you to look into the Debt Myth app. It’s an app that will help you debt out of debt once and for all. It’s really an amazing thing and I highly recommend it.