Which Debt Should You Pay Off First?

September 07, 2020 by First Federal Bank

debtBetween credit cards, student loans, car loans, and mortgages, you’re probably carrying some debt. On the surface, managing your debt can seem relatively easy — just make minimum payments. However, if you’d like to pay down your debts and increase your cash flow, you have some choices to make. Namely, which debt should you prioritize? Here’s a look at the advantages and disadvantages of each.

Highest interest

If you want to make your money go the furthest, personal finance website The Motley Fool recommends paying off the highest interest debt first. With this strategy, you’ll get rid of your costliest debt, so you’ll save money in the long run. However, there are potential downsides to this strategy. Your highest-interest debt may be your largest debt — such as a mortgage or a student loan. Bankrate contributor Nicole Dieker explains it can be extremely discouraging to spend years putting your money towards paying down a large debt to end up only covering the interest.

Lowest debt

If you enjoy the feeling of quick accomplishments, consider paying off your lowest debts first. This gives you a feeling of momentum that can be encouraging. Although you’ll ultimately pay more in interest over the life of the loan, The Balance contributor Miriam Caldwell advises you to knock out your lowest debts. In addition to giving you a feel-good rush of emotions, this can help eliminate troublesome calls from collection agencies.

High-credit-utilization debt

If you’re one of the many borrowers who’d like a higher credit score, consider paying down your debt with the goal of improving your credit utilization ratio. You’ll have a higher credit score if your credit cards aren’t maxed out. And once you have a higher credit score, you’ll be able to secure a better interest rate on your future loans. If you’re interested in taking this route, The Motley Fool recommends you prioritize paying down credit cards that utilize more than 30 percent of their credit limit.

Tax breaks

While paying interest can feel like bleeding money, it can also come with tax breaks, depending on the type of loan. For instance, paying your student loan interest provides a tax break. Although this doesn’t mean you should neglect paying down your student loans by only paying for interest, Caldwell explains you may see more financial advantages to tackling your credit cards first.

When you consider your unique goals and financial situation, you may find a hybrid approach suits your needs. For instance, you could pay down a few small debts, then switch gears and chip away at your high-interest loans. For guidance on paying down your debts, consult with a family member, spouse or financial planner. You can also search online for a debt repayment calculator, which can give you a clearer idea of how much interest you’ll be paying, how large your monthly payments should be and how long it will take to pay off your debts.

Categories: Mortgage Lending, Personal Banking, Saving Money, College, Financial Education, Credit Cards, Personal Lending, Taxes