Debt Relief 101: Which Debts Should You Prioritize?

Debt can often feel like a mountain that’s too high to climb. But here’s the thing: with the right strategy, it’s entirely possible to reach the summit and wave goodbye to that financial burden. 

A debt payoff strategy is crucial in effectively and efficiently tackling your debts. It gives you a clear path to follow and helps to keep you motivated as you see your debts shrinking. 

Discover the importance of focusing on high-interest debts, starting with the smallest debt, and prioritizing debt impacting your credit score. Find a debt payoff strategy that works for you.

The Avalanche Method

The “avalanche method” focuses on paying off the debts with the highest interest rates first. Why? Well, these debts cost you the most money over time. 

Imagine two debts, each $1,000. One has an interest rate of 20% and the other 5%. The first debt would cost you $200 in interest in a year if you didn’t pay it off, whereas the second would cost only $50. That’s a difference of $150, which you could use to pay off more debt, save, or cover other expenses. This method can be the most economical in the long run.

Pros:

• Interest Savings: The Avalanche method is mathematically efficient because you pay off your highest-interest debts first, saving you the most interest in interest over time.
• Accelerated Payoff: By targeting high-interest debt first, you can potentially speed up your debt payoff plan as you’re tackling the most “expensive” debt first.
• Long-Term Benefit: This method can provide significant long-term financial benefits, as less money goes towards interest.

Cons:

• Lack of Quick Wins: If your highest interest rate debt also has a large balance, it may take a significant amount of time to pay it off, which can be discouraging if you’re looking for quick progress.
• Motivation: Because you may not see debts disappearing quickly, staying motivated can sometimes be harder than methods that offer quicker gratification, like the Snowball method.
• Requires Discipline: This method requires strict adherence to the plan and disciplined budgeting to ensure that extra money is consistently applied to the debt with the highest interest rate.

The Snowball Method

The “snowball method” is all about starting with your smallest debt. It may save you less interest than the avalanche method, but it has a powerful psychological effect. Every time you pay off a debt, no matter how small, it feels like a victory, a step towards your goal. That sense of achievement can motivate you to stick with your debt payoff strategy and keep going.

Pros:

• Motivation Boost: By focusing on the smallest debts first, you can experience the satisfaction and psychological boost of ultimately paying off debts relatively quickly. This can motivate you to stick with your debt payoff plan.
• Simplified Finances: As you pay off your smaller debts, you’ll have fewer monthly payments to worry about, which can simplify your budgeting.
• Cash Flow Improvement: Eliminating a debt entirely frees up the minimum payment you made on that debt, improving your cash flow.

Cons:

• More Interest Over Time: Since this method doesn’t prioritize high-interest debt, you may pay more in interest over the life of your debts compared to strategies like the Avalanche method.
• Slower Debt Reduction: If your larger debts also have higher interest rates, it might take longer to reduce your total debt.
• Could Be Less Effective for Large Debts: If your highest interest debts are also the largest, this method won’t tackle them until the end, which could prolong the time it takes to become debt-free.

Biggest Impact to Your Credit Approach

Now, let’s consider the impact on your credit. If you have debts significantly impacting your credit score – like a delinquent loan or maxed-out credit card – it might make sense to prioritize these.

 A low credit score can make getting a loan, renting an apartment, or even getting a job harder. Prioritizing these debts can help you improve your credit score faster.

Pros:

• Credit Score Improvement: Paying off these debts can help improve your credit score faster, making it easier to get approved for new credit or loans in the future.
• Avoid Additional Fees and Interest: If you have debts in collections, paying them off could help you avoid additional fees and higher interest.
• Reduce Stress: Knowing that you’re taking care of the most damaging debt to your credit can reduce stress and provide motivation to tackle the rest.

Cons:

• May Not Save the Most Money: The debt with the most significant impact on your credit isn’t necessarily the one with the highest interest rate. So, you might pay more interest over time than strategies like the Avalanche or Stack method.
• Potentially Slow Progress: If the debt that’s most impacting your credit is also one of your largest, it could take a while to pay it off, which could be discouraging.
• Might Not Help Your Cash Flow: Smaller debts, even those that aren’t as critical to your credit, could be sapping your cash flow. You won’t address this issue immediately if you focus on the debt with the most significant credit impact.

Tool to Help You Figure Out Your Debt

Numerous apps and websites can assist you in sorting and managing your debt. These tools can help you track your debts, devise a plan to pay them off, and even negotiate with creditors on your behalf. Here are some you might find helpful:

7 Tips for Choosing the Types of Debts You Should Pay Off First

1. Consider the Interest Rates: Debts with higher interest rates cost you more over time. Therefore, it can be beneficial to pay these off first, as in the Avalanche or Stack method.
2. Look at the Balances: If you have a few small debts you could pay off quickly, it might make sense to pay these off first for a quick win and less stress, as in the Snowball method.
3. Consider the Impact on Your Credit Score: Debts that are delinquent, in collections, or close to their credit limit can negatively impact your credit score. Focusing on these debts first might be beneficial to prevent further damage to your credit.
4. Think About Tax-Deductible Interest: Some types of debt, like certain student loans and mortgages, have tax-deductible interest. It might make sense to prioritize other debts over these since the tax deduction effectively lowers the interest rate.
5. Secured vs. Unsecured Debts: Secured debts are tied to an asset, like your home or car. If you default on these debts, you could lose the asset. Therefore, it’s generally essential to prioritize these payments.
6. Consider the Terms of the Debt: Some debts may have terms that make them more important to pay off quickly. For example, if you have a credit card with a 0% promotional rate about to end or a loan with a balloon payment coming due, you might want to prioritize these.
7. Take Care of Necessities: Make sure to keep up with payments that cover necessities like utilities, as interruptions to these services can cause a lot of inconvenience or even danger.