Which Debt to Pay Off First? Five Debit Categories to Prioritize

profileErin Bruehl | September 7, 2022
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We all know that paying off debt is good for us, but if just knowing what to do were enough to make great things happen, none of us would have any debt to pay off.

The good news is that there are a number of different methods for paying off debt, not just one because this is not a one-size-fits-all situation. Everyone is motivated differently, so consider the options for paying off debt before diving into a new plan of action.

1. Pay Back Debt Owed to Friends and Family First

When we’re struggling with debt, it’s normal to turn first to friends and family to give us a hand. Unless those friends and family are independently wealthy and make it clear that the money is a gift and there’s no need to pay it back, this is almost always a situation that must be addressed first. Though it may be easier to get a personal loan from a friend or family member than to go to a bank, you don’t have to see the bank owner at your son’s birthday party or a family reunion.

In short, owing money to family members or friends can be awkward. Since one of the primary goals of debt payoff is to regain confidence and feel stronger in the world, it is recommended to pay off loans to friends and family before doing anything else.

Who This Method Works For:

  • Anyone who has borrowed money from friends or family and possibly allowed months to pass without repayment
  • Anyone who tries to avoid seeing or talking to a family member or friend out of fear that the conversation of money will come up
  • Anyone who would like to make their personal life a little more comfortable

2. Pay Off the Smallest Debt First: The Snowball Method

For those who have a lot of little debts to work with and feel overwhelmed by all the minimum amounts that need to be paid in full and on time every month, the snowball method is the way to go.

It starts by making a list of all debts owed from smallest to largest, creating a budget that allows you to make all minimum payments, and then allocating any extra money each month to the balance of the smallest debt.

When the smallest debt is gone and out of your budget, you take the amount you were paying toward the minimum and add it to the minimum payment for the next smallest debt on the list. Then, you add whatever extra money you have each month to that payment until that debt is gone.

This is a great option for debt payoff because it’s exciting to see yourself make progress. For example, let’s say you have an $800 debt that requires a $50 minimum payment each month, a $1,500 debt that requires a $100 payment each month, and a $5,000 debt that requires a $200 payment each month.

If you pay the minimums and have $200 extra in your budget, you will pay off the $800 debt within a few months. Then, you’ll be able to add the $50 minimum payment that was going to that debt to the $100 payment for the $1,500 debt and then throw the extra $200 a month on top of that. Now, you’re making $350 payments toward the $1,500 payment each month, making it go away just as quickly as the $800 debt.

When that is paid off, you’ll put $50 (minimum payment for the paid-off $800 debt) + $100 (minimum payment for the now-paid off $1,500 debt) on top of the $200 minimum payment for the $5,000 debt (which should be closer to $4,000 since you’ve steadily been paying the minimum while paying off other debt). Add the $200 extra per month to that amount, making monthly payments of $550 payments to the largest debt, and you’ll pay it off in under a year.

Notice the snowball effect there? Every time you pay off a debt, the minimum payment for that debt is added on to the minimum payment for the next debt, essentially snowballing payments so they grow every time you pay off a new debt. This makes those larger debts feel much smaller and easier to manage.

Who This Method Works For:

  • Anyone who gets discouraged by seeing no change in the budget despite months of working to pay off debt
  • Anyone who has tried the “pay the highest interest rate” type of debt payoff plan and failed
  • Anyone looking to celebrate the wins and stay motivated to pay off all their debt as quickly as possible
  • Anyone who has irregular income that might make it difficult to consistently put large sums toward debt payment

3. Pay Off Debt With the Highest Interest Rate First: The Avalanche Method

When most people lay out their list of debts and see how much interest they owe on credit cards or how much interest they’ve paid out over the years on big school loans or mortgages, they are shocked. Interest adds up quickly, and it’s upsetting to watch hard-earned money evaporate with nothing to show for it except an item or experience that may be a long time in the past.

As a result, many people choose to pay off high-interest debt first, hoping to save as much of that money as possible and put that saved interest toward paying off the next debt. This is called the avalanche method because it theoretically describes a process in which money that would have been put toward interest is now put toward paying off debt instead.

The avalanche method is a very economical approach, but unfortunately, if the highest interest is attached to a relatively large debt (for example, a debt that amounts to more than 10% of your annual income), it’s going to take so long to pay it down that many people become unmotivated and lose interest in the project entirely, ultimately giving up and seeing no progress for their hard work.

Depending on the amount of the different debts and the interest rates, this method may be very similar in practice to the snowball method.

Who This Method Works For:

  • Anyone who has a large amount of money in hand to put toward debt payoff and/or extra income that will help them pay off high-interest debt more quickly
  • Anyone who is very analytical and motivated by the numbers above all else
  • Those who have never attempted to pay off debt before and feel uninterested in any other method
  • Those who have a group of debts that are relatively close in size (all within a few hundred dollars of each other) regardless of the interest rates

4. Pay Off the Debt With the Highest Monthly Payment First

If you have a tight budget and you don’t have much extra money each month to work with, your first priority for paying off debt may be to put a little bit more breathing room into your monthly budget.

For example, if you are paying $500 a month toward one bill when you are bringing in $3,000 a month in income, your financial world will feel much less stressful when you have that $500 available to put toward other financial goals. For this reason, some people opt to focus first on paying off debt with high minimum payments that, when gone, will create the most room in their budget.

Who This Method Works For:

  • Those who have a bill that has huge monthly payments for a debt that is lower than other debts on the list
  • Anyone with a primary goal to create more breathing room in their monthly budget
  • Anyone who has a decent chunk of unexpected money to put toward debt payoff and has the ability to wipe out a debt with a high monthly payment quickly
  • Those who have income that varies from month to month and get large payments that can be used to make the monthly budget less stressful during lower income months

5. Pay Off Credit Cards First

Credit cards charge an exorbitant amount in interest and late fees, and over-limit charges can be debilitating. If your debt list includes a number of small debts on store credit cards and/or credit cards that are over the limit, it may be prudent to focus on getting these cards under the limit as soon as possible and then working on wiping them out completely.

In some cases, this method is the perfect marriage of the avalanche method and the debt snowball method, allowing you to pay off the smallest debt with the highest interest or fees first. Then, when it's paid off, put that minimum payment you were making toward the next card.

Who This Method Works For:

  • Anyone who has credit cards that are currently over their limit
  • Anyone whose credit is negatively impacted by having too many credit cards or over-the-limit credit cards
  • Those who are shocked by the high rates of interest on credit cards and/or high fees with late payments and motivated by the idea of stopping those fees
  • Those who want to make their budget more manageable in terms of making payments to multiple creditors and have a number of low debts across different credit cards

6. Pay Off the Debt That Will Have the Biggest Impact on Your Credit Score First

If your goal is to increase your credit score, paying off debt will certainly help, especially if you are making regular payments on time.

However, credit scores rate different types of debt differently. Being completely debt-free — no mortgage, no school loan, no credit cards, and no car loan — may actually cause you to have a low credit score or no credit score at all.

This is not a bad thing if you will have plenty of money saved to make your next large purchase and won’t require a loan. But while you are in the process of paying down your debt and improving your credit score, you may find value in paying off debt in a way that protects your score.

This means that if you have multiple credit cards with debt, you should not pay off your oldest credit card that gives you a long credit history first. Pay off newer cards and then keep the older card open once it’s paid off. It may also mean that if you have multiple school loans, a mortgage, a car loan, and credit card debt, you pay down all but one in each category until you are ready to pay all of it off.

Credit scores find value in your ability to manage different types of credit, so pay off all your credit cards but leave your oldest ones open. Then, pay off two out of three student loans and keep making minimum payments on the third. Do the same with other loans, so you have a variety of credit throughout the debt payoff process.

Who This Method Works For:

  • Anyone who may need to buy a car or home or have their credit checked by employers in the next year or two
  • Anyone who is focused on getting a higher credit score

No Matter How You Do It, Paying Off Debt Is a Great Financial Choice

At Current, we know that paying off debt is one of the best things you can do for your peace of mind and your financial future.

To assist you in this process, we have made it possible for you to get your paycheck up to two days faster with direct deposit when you sign up for a Current Personal Account with us today.


References

Why Pay Off Loans Early? (February 2022). The Balance.

How to Lend Money to Family and Friends. (September 2021). U.S. News and World Report.

How the Snowball Method Works. (September 2021). Dave Ramsey.

15 Incredible Debt Snowball Worksheets to Get Out of Debt. (March 2021). Logical Dollar.

The Debt Avalanche Method: How It Works and When to Use It. (January 2020). Experian.

If You Have Multiple Credit Card Balances, Here’s Which One You Should Pay Off First. (January 2022). TIME.

Here’s How to Decide What Debt You Should Tackle First. (June 2021). CNBC.

How Debt Affects Your Credit Score. (June 2021). The Balance.


Current is a financial technology company, not a bank. Banking services provided by Choice Financial Group, Member FDIC.

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