Determining the Order of Paying Off Your Debts

There are two main schools of thought about setting up a debt payment plan. 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 getting out of debt as quickly as possible. Learn what debt payment strategy is best for you. 

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, you will save on interest in the long run, and you will free up even more money to put toward your other debts. 

However, if your highest-interest 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 stay focused and stick to your plan when it doesn't feel like you're getting closer to your goal.

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: As you knock off your smaller debts one by one, 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.

Think About Tax Breaks

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There are loans—student loans, for instance—that give you a tax break on the interest that you pay. This should not be a reason to exclude it in your debt snowball, but these are safer debts to put lower on the list since they will benefit you financially in other ways.

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. 

Take a Balanced Approach

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As you set up your debt payment plan, you need to create a strategy 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 a second mortgage. These debts may also have lower interest rates. Consider your options, and choose the plan that will save you the most, but also seems attainable.

Stick to Your Plan

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Once you begin paying off your debts, it's critical to 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. 

It's also important to find ways to stay motivated. Try keeping a debt payment chart where you track your progress, and don't forget to celebrate each milestone along the way.

Updated by Rachel Morgan Cautero.