Determining the Order of Paying Off Your Debts

When setting up a debt payment plan, there are two main schools of thought. One strategy is that you should pay off your debts from the highest interest rate to the lowest because this will save you the most money over time.

The other school of thought says to pay off the debts from smallest to largest so that you can gain more momentum on your debt payment plan, which may help you to pay off the debts more quickly.

Regardless of what strategy you choose, with a solid plan in place, you can focus on paying your debts and getting out of debt as quickly as possible. Learn what debt payment strategy is best for you. 

01
Reasons to Pay Off Your Highest Interest Debts First

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To many, it makes sense to pay off the highest interest rate debt first​ because this debt is costing you the most money each month. If you can pay off this debt, then you will free up even more money to put toward your other debts. 

However, if your highest interest rate debt is also your largest debt, you may spend more than a year paying it off. Then you may not feel like you are making any real progress on becoming debt free. It can be difficult to maintain focus when it takes a year or more to pay off just one debt. 

02
Reasons to Pay Off Your Smallest Debts First

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You can gain a certain amount of satisfaction from paying off your small debts first. Here's why: You'll feel like you are actually making concrete progress toward your financial goal of becoming debt-free. You will also free up some extra cash once you pay off these smaller debts to put toward your next largest debts. 

However, a drawback of this debt payoff strategy is that you will still be paying interest payments on the larger debts, which can mean that you will end up paying more in interest in the long run.

03
Think About Tax Breaks

interest-rate-tax-breaks

There are loans like your student loans and mortgage that give you a tax break on the interest that you pay. this should not be a reason to not include it in your debt snowball, but it would make sense that this would go later on your list.

For example, you may want to tackle your credit card debt and then work on your student loans (which also usually have a lower interest rate) since you can deduct a percentage of the interest you pay on your student loans when filing your taxes

04
Take a Balanced Approach

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As you set up your debt payment plan, you need to create a plan that will work the best for you and help you reach your financial goals as quickly as possible. You can take a more balanced approach to your debt payment plan.

You may have several debts that you know you can knock out in just a few months, and you may put those at the front of your debt payment plan. Then you can determine if you want to work on the smallest debts or the highest interest rates first.

If you have credit cards with the same interest rates, you may want to pay off the smallest balance first and then work on the largest. 

You also may want to put the loans that save you on your taxes at the end of your debt payment plan. For example, your student loans, home equity loans, or second mortgage. These debts may also have lower interest rates. 

05
Sticking to Your Plan

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Once you begin paying off your debts, you need to make sure you stick to your debt payoff plan. This means applying the extra cash to your next largest debts, making extra payments on your other debts, or even increasing your monthly payment. 

You also need to stay motivated. A debt payment chart where you track your progress can help, as well as celebrating each milestone along the way.

Updated by Rachel Morgan Cautero.