How to Decide Which Debt You Should Pay Off First

How to Figure Out Which Debt to Pay Off First

Becoming debt-free can take a lot of weight off your shoulders. If you are struggling to manage your credit cards, car loans, and the cost of living in your city, you are not alone. But when you’re ready to make a change, how do you know which debt to pay off first?

Making the minimum monthly payment on the debt that you owe should be the bare minimum, but the repayment strategy that best fits your situation will depend on your goals and preferences. There is no one-size-fits-all solution to get out of debt! Before you can get introduced to different repayment strategies, it’s important to ask yourself these three questions about your debt:

What bill or expense am I struggling to pay the most every month?
Am I living outside of my means?
Can I realistically increase my budget to pay off my debt faster?

With the answers to these questions in mind, you can more accurately assess your financial situation and determine what debts you should pay off first.

Assessing Your Financial Situation

If you are concerned about your debt, understand that stress about money can directly impact your well-being. Getting out of debt can be incredibly beneficial to your financial and mental health! After you’ve answered the preliminary questions about your money, the next step to becoming debt-free is to create an itemized list of your income, current budget, and debt obligations.

In order to accurately compare your income to your debt, you can add up your monthly payments and divide that total by your gross monthly income. Then, multiply that number by a hundred. This will show you the percentage of your income that is dedicated to paying off your debt per month. If you are concerned about your financial situation being unhealthy, keep in mind that most experts recommend having a debt-to-income ratio under 30%. If you are consistently spending close to what you make each month, you may be living outside of your means.

For example, let’s say that your gross monthly income is $4,200, and your total debt payments are $1,800. We can use the formula above to calculate your debt-to-income ratio, which would be 42.86% in this scenario.

Factors that Matter When You Decide Which Debt to Pay First

Now that you have a better idea of your current debt, here’s a list of the factors that can directly impact your decision to tackle a specific loan or credit card before the others:

Type of Debt Obligation: The type of debt that you have matters because some forms of credit can be more difficult to deal with than others. For example, if you have a maxed-out credit card with a variable interest rate, that typically requires a greater sense of urgency than a car loan with equal monthly installments. Credit cards often have higher interest rates than other forms of credit because they are an unsecured debt.
Closed Accounts and Late Payments: Having defaulted or closed accounts can negatively impact your credit score. If you have an account in poor standing and you are behind on your payments, that should be your primary focus when figuring out how to prioritize repaying your debt.
Interest Rates: Loans and credit cards with higher interest rates tend to cost more to pay back over time, so it can be smart to prioritize paying off the applicable balances as much as you can. You may have trouble paying off your debt if the interest rate is variable and you are struggling financially. If the interest rate of a loan or credit card is variable, it means that the annual percentage rate (APR) can increase or decrease. If you’re asking yourself, “Which credit card should I pay off first?” The answer is that depending on your financial situation, the minimum payment on all your credit cards or loans may be all that you can afford to make each month. But if you have a loan or card with a variable interest rate and a high balance, you should try to pay it off as soon as possible.

Strategies for Prioritizing Your Debt Payments

Not sure which debt you should pay off first? With the factors mentioned above in mind, try to explore the most popular debt repayment strategies:

Debt Snowball

The debt snowball method involves paying off your smallest debts first. Think of it like knocking out the low-effort chores on your list before you need to tackle the big things, like putting away laundry or grocery shopping. If you take out the smaller players ahead of time, it can give you a little bit of breathing room to focus on the bigger problems later on. But how do you know which bills to pay off first?

Try to prioritize low balances on credit cards or car loans. With this repayment strategy, you are supposed to pay off your smallest debts in quick succession. Rinse and repeat this process until all of the applicable debt is gone, and then use the available money in your budget to deal with the larger obligations.

Debt Avalanche

This repayment strategy is the aggressive version of the snowball method. A debt avalanche involves paying the debt with the highest interest rate first. With this strategy, your goal should be to make the minimum payments on your credit cards or other debt and focus your extra cash on the loan or credit card with the highest interest rate.

Paying the Debt That Most Directly Impacts Your Credit

There are a few different ways that your debt can impact your credit. As a general rule of thumb, the debt you should pay off first needs to be any past-due accounts that you have. You can minimize potential damage to your credit score by getting your accounts back in good standing.

If you have maxed out credit cards, your credit utilization rate is likely very high, and that can negatively affect your score. Paying off your revolving debt, like credit cards, can positively impact your score. It won’t happen instantaneously, but it is a step in the right direction, especially if your cards have high interest rates and maxed-out balances.

Revolving credit such as credit cards will have spending limits, but there is no set loan term to pay them back, unlike installment loans. It can be easy to get in over your head in debt with revolving credit because you aren’t given a lump sum to pay back over time.

Paying off installment loans can temporarily ding your credit in some cases. If paying off your car loan messes with your credit mix, your score may drop slightly if you have less variety with your debt obligations. That being said, it is still important to pay what you owe, but you should prioritize the debt that is significantly impacting your financial health first. Your credit score is just one piece of your overall financial well-being, but it does impact your ability to secure housing, loans, and employment, in some cases.

Consider Multiple Approaches

As mentioned above, the repayment method that works for one person may not work for you. It’s okay to try multiple approaches and find the right fit for your finances! You can start with the snowball method and switch gears to the avalanche method if it doesn’t end up being the best fit for your situation.

How to Stay Motivated During the Repayment Process

Some people find that the snowball method is the best way to stay motivated during the debt repayment process. By paying off the smallest debts first, you can get a sense of accomplishment before you deal with the more overwhelming obligations.

Regardless of which debt you pay off first or the repayment method that you choose, you can motivate yourself by creating a tracker that shows the progress that you’ve made over time. Make sure to use a budgeting app like Rocket Money to stay on top of your money and track your spending as much as possible!

When to Consider Debt Consolidation Loans

If you are juggling multiple credit cards with high interest rates and balances, it may be in your best interest to explore other options for dealing with your debt. Debt counseling is one avenue to negotiate with your creditors and potentially get reduced monthly installments or lower interest rates.

Another option to explore is debt consolidation loans, such as car title loans or personal loans. With a debt consolidation loan, you can pay off your existing debts and focus on one larger payment each month. A debt consolidation loan can be less of a headache than multiple debts because you don’t have to keep track of different interest rates and payment due dates at once.

With a title loan, you can use your car’s title as collateral for the loan and keep your car during the repayment process! If you are eligible for a title loan serviced by LoanMart, you can access competitive interest rates and receive up to $15,000 in as little as 24 hours. Complete a short questionnaire to see if you qualify for instant pre-approval!^{1 3}

How to Decide Which Debt You Should Pay First