Determining the Order of Paying Off Your Debts

When you are setting up your debt payment plan, there are two main rules of thought about the order that you pay off your debts. One theory 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 wants you 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. With a solid plan in place, you can focus the extra money you have to pay your debts to help you get out of debt as quickly as possible. 

Reasons to Pay Off Your Highest Interest Debts First

Stressed woman with hand in hair holding credit card at computer in home office
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It makes sense to pay off the highest interest rate first​ because this debt is costing you the most money each month. If you can clear it up, then you will be able to gain more traction over your finances.

However, if this is your largest debt you may spend more than a year paying it off, and you may not feel like you are making any real progress on your debts. It can be difficult to stay focused on paying off the debts when you do not have the satisfaction of paying off a credit card or other loan.

Reasons to Pay Off Your Smallest Debts First

You can gain a certain amount of satisfaction from paying off your smallest debts first. You can clear up a lot of smaller monthly payments and quickly apply those to the extra money you are paying off on your debt snowball. It may seem like a great way to start out on your debt payment plan, but you may lose some of the tax benefits or end up putting the highest interest loan last. This means you may end up paying more in interest in the long run.

Think About 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 the debt.  

Consider Building Up Your Snowball

If you have a lot of smaller monthly payments for things like medical debt or past due utility bills, you may want to put these at the front your debt snowball even though they may not have the highest interest rate because you can use those payments to help build the extra amount you pay on your debts and it will get your debt snowball rolling. It can be very beneficial. 

Take a Balanced Approach

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 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. If the rates are within a percentage point or two, and you know you can pay off the smaller ones more quickly, giving you more power to pay off the larger loans you may want to do that.

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

Sticking to Your Plan

Once you begin paying extra money on your loans, you will need to make sure that you put the extra payments to the best use for your loan. This may mean making one additional payment a month on the loan, or just adding extra money to the payment you are already making.

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

As you do this, you will finally be able to live debt free. As the terms of your loans change or your current situation changes, you can make adjustments to the order of your debt payment plan, but you do need to keep paying extra each month.