I get the question of “what debt should I pay off first” many times. Not just by readers, but by friends and family members as well. In general, there are two approaches you can take when paying off your debt. You just have to determine which one makes the most sense for you. Let’s look at your options in depth.
What Debt Should I Pay Off First?
Here are your two primary options for paying off debt. You can combine these and tweak them around a bit, but overall, these are the two methods most people use.
Option 1 is to pay off the highest interest rate debt first. This approach will save you the most on interest charges but it may take you longer to get out of debt.
Option 2 is to pay off the smallest debt balance first. This approach provides you motivation to stay on the path of paying off your debt. Of course, you may end up paying more in interest with this option.
Highest Interest First Option
The first option is save the most on interest charges. Let’s look at how this option works.
Let’s say you have 2 loans as seen below:
- Loan #1: $10,000 10%
- Loan #2: $15,000 20%
Following the high interest first method, you would pay the minimum balance on loan #1 and put the rest of the money you can afford to pay off your debt towards loan #2. Once loan #2 is paid off, the entire amount you have earmarked for debt repayment would go towards loan #1.
In this case, you would save the most in interest charges because you paid off the debt that was costing you the most first.
Smallest Balance First Option
The second option is to pay off the smallest debt the quickest. Let’s look at how this option works.
Again, let’s say you have 2 loans as seen below:
- Loan #1: $10,000 18%
- Loan #2: $5,000 13%
With the smallest balance first method, you would pay off loan #2 first since it has the smallest balance. You make the minimum payment to loan #1 and put the rest of the money you have set aside for debt repayment to loan #2. Once loan #2 is paid off, you will put the money you were using to pay off that loan towards loan #1.
Advantages And Disadvantages Of Each
Each method has advantages and disadvantages. With the highest interest first option (option #1) we will pay the least amount of interest in total since we are eliminating the debt with the highest interest rate first. The disadvantage to this option is that in some cases, it can take longer to pay off the debt, both in the long term and short term.