Knowing Which Debt to Pay First

It can seem intimidating trying to know which debt to pay first. There are two very popular methods when it comes to selecting how to pay off your debt, offered by Suze Orman and Dave Ramsey.  I have read every book both of them have published. I find their advice extremely valuable. Does all of it really fit me and my life- no not always.

But taking control of your financial situation even in baby steps is better than nothing at all. I can not tell you which one is better because it really does come down to what you will stick with and what makes you want to continue on this journey. But I can tell you a little bit about each and how I use both methods at times with my own tweaks.

Debt Avalanche Method- Compliments of Suze Orman

If you don’t know who Suze Orman is you can read more about her here. The concept behind this is you start paying off your debt based on the amount that has the highest interest rate. You still pay your minimum on all other debts while making extra payments to the debt with the highest interest rate. Once you pay off the debt with the highest interest rate you then apply those payments in addition to the minimum payment on the next highest interest rate.

Why this works: The interest rate on your debt is what keeps you trapped. The higher the rate the more you are paying on your debt and the longer it will take to pay off. In the end, you will be saving money on the interest you would have had to pay.

The downside: It may take a little longer to have one balance paid off in full.

Debt Snowball Method- Compliments of Dave Ramsey

If you don’t know who Dave Ramsey is you can read more about him here. The concept behind this is that you start paying off your debt based on the account with the smallest balance. If you have debts with the same balance, then you go with the one with the highest interest rate. You still pay your minimum payment on all other debt while making extra payments to the smallest debt. Once you pay off the debt on the smallest amount you then apply those payments in addition to the minimum payment on the next lowest debt.

Why this works: Faster progress. You get the satisfaction of paying off a bill completely faster.

The downside: You pay more in interest while paying off smaller debts.

How they both work:

Regardless of which method you choose, they both work the same way. Say your minimum payment on Debt 1 is $20. You have an extra $20 that you are going to apply to Debt 1. So right now every month you are paying $40 on Debt. 1. Once you have paid off Debt 1 you apply everything you were paying on Debt 2 plus the minimum payment.

If Debt 2’s minimum payment is $20 and you now apply Debt 1’s $40 payment you are now paying $60 on Debt 2. Once Debt 2 is paid off you apply the $60 to Debt 3 minimum payment and so on until you have paid off all your debt. The only difference is if you are going after high-interest rates first or smaller debts.

How I know Which Debt to Pay First:

For me, it comes down to the debt. I prefer instant gratification and so I am more attracted to the debt snowball method. Also at the same time, I love to save money and at times I see the most benefit in skipping out on interest rates. Knowing which debt to pay first for me actually comes down to what the debt is.

Student Loans

I currently have a stupid amount of student loans. I didn’t start paying mine off right away and I deferred them multiple times back in my “I know nothing about money” days. The interest has just been stacking up on them. I had decided that while I am not focused on paying off my student loans at the moment, I did want to minimize the interest I am paying. Did you know you can apply payments to individual groups of your student loans?

Until recently, I didn’t know that even though I had one student loan payment it was broken down into 6 different groups. Each group has a balance and a different interest rate. I can apply payments to go to specific groups. So while I make my minimum payment to each group I pay a little extra to the groups with the 6% interest rate. It is not enough to pay them off super fast but it is enough to help with the interest.

Credit Cards

I am a big fan of taking advantage of 0% interest offers. You have to be extremely disciplined to make sure you are not getting your self into trouble with these. I took advantage of this when buying furniture for our new house. It was a 4 year no interest if paid in full in the 4 years.

What a lot of salespeople don’t make super clear to you is that at the end of the 4 years if your balance is not paid in full you pay the amount of interest that has accrued over those 4 years. That is no fun! So if I do want to take advantage of this kind of offer I always do the math first.

I calculate how much I would have to pay every month to make sure it is paid off in 3 years and 10 months. Always make it shorter than the full term amount! If I know I can’t make those monthly payments then something has to give. Either I don’t need to buy everything or I pay cash for some and use the offer for the rest. DO NOT get your self into a situation you know you can’t afford and whish for the best.

When we decided to pay off our debt to buy a house we focus on our small debts at first to get them out of the way and feel like we were accomplishing our goals. For us, most of our debt had high crazy interest rates anyway and so the thrill of paying something off was bigger than the interest.

Money with Emotions

Do you have a debt that just brings up any emotion with it? If so this is where I would start. Being free of something that once may have caused hurt, anger, or sadness is just going to bring you so much more satisfaction. Think of it as closing a chapter in your life only to start a new better one.

Emergency Funds

Of course, paying down debt also means making sure you don’t incur more while you are paying it down. Consider starting an emergency fund first to make sure you can cover anything that pops up, thus keeping you from having to use a credit card. Read more about emergency funds here. After you have set that up you can truly focus on which debt to pay first.

Just Make a Start

In conclusion, try one plan and stick with it. Focus all your effort in paying off one debt at a time. If you are unsure of which debt to pay first, just pick one and go for it! Regardless of which method you chose you will be successful if you show commitment to it. Dedication is the real key to success here. I would love to hear your success stories!