Which Debt Should You Pay Off First?

Which debt to pay off first
Key Takeaways:
  • Before you start a repayment strategy, take stock of your debts, including the interest rates and balances.
  • Many strategies will work. Select the one that’s most appealing.
  • You can negotiate collection accounts.

Nowadays, it’s common for people to have several loans and credit cards. If your debt is out of control, you can turn things around with good strategies and commitment. 

Before starting your debt repayment journey, choose which debt to pay off first and select a repayment strategy. There isn’t just one right way to do it. It only matters that you start.

How to choose which debt to pay off first

Many people choose to start with either the most expensive debt or the smallest outstanding balance. 

To make this choice, you need to understand the type of debts you have, their costs, and outstanding balances. Gather all your debt information, including mortgages, student loans, auto loans, personal loans, and credit cards. 

Type of debt

Debts are either secured or unsecured. 

Secured debt: you borrow against an asset. That means you offer something valuable to the lender in order to get the loan. It’s common when borrowing for a house or car. If you fail to repay the loan, the lender has the right to take steps to sell your asset and get paid back.

Secured loans might be cheaper than unsecured debt because lenders have a higher chance of recovering any outstanding amounts. 

Unsecured debt: loans without collateral. This could be a personal loan, federal student loan, or traditional credit card. 

Lenders offer unsecured debt based on your creditworthiness, which includes your credit score and other factors like your debt-to-income ratio. You don’t have to offer anything of value to the lender as collateral.

You’ll likely pay higher interest rates for certain unsecured debts like credit cards because they’re a higher risk for the lender compared to secured debts. Lenders have a lower chance of recovering any outstanding amounts if you stop paying.  

Some experts advise that you prioritize secured debts over unsecured debts because you could lose something of value if you are unable to pay them off. 

Cost of debt 

This is essentially your total interest cost over the duration of the debt. 

Your annual percentage rate (APR) lets you calculate how much the debt will cost for one year. The APR includes your interest rate and fees, so on your mortgage the APR might be higher than the interest rate. You don’t have to worry about complicated calculations. Just write down the interest rate for each debt so that you’ll know which ones cost you more over time.

Outstanding balance

Know how much you owe each creditor. You should also list the required monthly payment for each debt. 

Your credit card statements will tell you your required minimum payment. Just keep in mind that as you pay down your balance, your minimum payment will go down. If you pay less, it’ll take longer to pay off the debt. Sometimes it’s a good idea to stick with the same monthly payment even if you’re allowed to pay less. 

Installment loan minimum payments don’t change as you get closer to payoff.

Debt payoff strategies 

Once you know the details of your debt, select a repayment plan that suits you.

Let’s assume you have the following credit card debt:

DebtOutstanding balanceAPR
Credit card A20,00024%
Credit card B10,00019%
Credit card C5,00022%

Here’s how you can use different repayment strategies to pay off the above:

Debt avalanche

Debt avalanche is paying off your debts starting with the highest interest rate. The thinking is that you want to get rid of the debt that’s costing you the most.

In the above example, you’ll make minimum payments to card B and card C. You’ll put every spare dollar to card A. Once you pay off card A, you’ll put every spare dollar to card C while making minimum payments on card B. Then you’ll tackle the last card.   

Paying off the most expensive debt first helps you lower your overall costs. But if your high-interest debt is large, using the debt avalanche method might mean it takes longer before you reach the first payoff.  

Debt snowball

Debt snowball is paying off your smallest debt balance first and working your way up to the largest balance. You’ll get to your first payoff most quickly, which can be a big motivator to keep going.

In the above example, you’ll start putting every available dollar toward card C while making minimum payments to the others. Once you pay off card C, you can move to card B, followed by card A. 

Pro tip: Remember to make minimum payments on all your debts. Your payment history is the most important item in your credit score calculation. And paying on time helps you avoid late payment fees. 

Debt consolidation loan

Debt consolidation is getting one loan to pay off multiple loans or credit cards. 

This method can save you money if the new loan’s APR is lower than the APRs for your other debts. Your loan interest rates will typically depend on your credit history. 

There are several ways to consolidate debt:

  • Personal loan.

  • Home-equity loan. Home equity is the difference between what your home is worth (market value) and your outstanding mortgage balance. If your home is worth $350,000 and your mortgage balance is $200,000, you have $150,000 in equity. 

  • Credit card balance transfer. Some credit cards offer zero interest or very low interest for a period of time. If you’re not paying interest, your entire payment will lower the balance you owe and you can get out of debt sooner. The interest rate will jump up to the regular rate after the promotional period ends.

Pro tip: When you apply for a new credit account, lenders make a hard inquiry into your credit. This is likely to temporarily lower your credit score. Some lenders offer prequalification with a soft inquiry, meaning you can check out your options without it showing up on your credit report or affecting your credit score.

Pros and cons of debt repayment strategies

Repayment strategyProsCons
Debt avalancheLower cost
Finish your total payoff faster
Longer time to first payoff
Debt snowballFaster time to first payoff
May take longer to full payoff
Higher overall cost
Debt consolidation loanOne payment replaces multiple payments
Potentially lower overall cost
May take longer to pay off debt
Might not save money if you take more years to pay

Which debt repayment method should you choose?

The best repayment strategy for you depends on your preferences. Select a method that’s most appealing, so you’ll be more likely to follow through. 

If you can stay disciplined, the debt avalanche method might be a good option because of the cost savings. 

For some people, the debt snowball method works the best. Getting to the first win quickly can help you keep going.  

If you’re overwhelmed with payments or having a hard time tracking multiple debts, debt consolidation might be an ideal strategy. It’s a good option if you can lower your overall interest charges. 

How to pay off debts in collection

You can negotiate with collection agencies to lower your debt.   

If you haven’t paid your loans or credit cards in several months, your debt might be with a collection agency. This happens to many people. If debt collectors are bothering you, there are different ways to deal with collection agencies

You can negotiate with them yourself. If you’re not comfortable doing so, you can hire a professional debt relief company to help you. 

Start sooner rather than later. Sometimes it’s possible to settle your debt after a lawsuit is filed but it can be easier to negotiate before a judgment is in place.