If you are in debt, you are not alone. On average, households in the United States have over $15,000 in debt. Almost half of this comes just from credit cards. Clearly, debt can be difficult for people to manage. However, for many people debt is also a difficult topic to discuss. Creditcards.com conducted a poll asking Americans what topics they would be uncomfortable discussing with a stranger. Debt was one of the least comfortable topics to discuss, coming in behind salary, weight, politics, and religion. Not talking about debt could be why people sometimes use the wrong strategy when choosing which debt to pay first.
There are two main strategies, working on the lowest amount debt first, or the debt with the highest interest first. Even experts disagree on which strategy is the best, and it can vary from person to person. Check out this article for a bit of the debate between debt experts. What works for you may not work for your friend. Keep reading to help decide what the best strategy is for you.
[Read: Is It Possible To Save While Paying Off Debts?]
Pay Off High-Interest Debt First
- Focus on most expensive debt in long-run
Mathematically, this is the best strategy for deciding which debt to pay first. It helps you avoid making more interest in the long run. For this strategy, you continue to pay the minimum payments on all your debt, except for the one with the highest interest rate. You should pay any amount you can afford to pay off this debt first. The logic behind this strategy is that you will save the most money overall. The downside to this strategy is that it may take a while to pay off the first debt. The slow progress may make you less motivated to continue tackling your debt. If you choose this strategy for which debt to pay first, it is important to be determined, and self-motivated.
Once you have paid off the first debt, you can “snowball” the next payment. Choose the account with the next highest interest rate and focus on this one. Now that you have paid off the first debt, you can take the money you were putting toward the first debt, and work on your second debt. This is the snowball effect, because each time you pay off an account, you have more money to put towards the next account you decide to focus on.
Prioritize Lowest Amount First
- Lowest amount debt paid first
With this strategy, as with the first one, you should still continue paying the minimum balance on all your accounts. However, instead of choosing the highest interest debt to pay first, you should focus on the lowest amount of debt first. As with the previous strategy, there are pros and cons to this method of deciding which debt to pay first. The main con of this strategy is that it will often cost you more in the long-run. Your lowest amount of debt is most likely not your highest interest debt. This means, as you focus on paying down the lower amounts, your higher interest accounts will still be accumulating interest. Based solely, on mathematics, there is a clear advantage to choosing the highest interest debt to pay first. So why do experts say there are two methods? Paying down debt is a daunting task, which requires financial self-discipline and lots of motivation. This is what the lowest amount method provides – motivation. Paying the lowest debt first lets you cross off an account quicker than if you paid off larger, high interest accounts first. Being able to cross that account off the list of debts provides many people with an instant boost of confidence and motivation. It helps seeing that you have accomplished something, and are on your way to achieving your goal. One study from Texas A&M University has begun to investigate how this effect works. Their findings suggest that paying the lowest balances first helps people build their motivation, but the subject still needs to be studied further to be conclusive.
[Read: Do I Repay Debt Or Invest?]
Which Strategy?
- Strategy depends on personality
- Either method leads to no debt
With all this information, how should you go about choosing the best strategy for you and your debt? One important thing to remember is that everyone’s situation is different. People have unique personalities and debt situations, which should be considered when choosing a strategy. Do you need the confidence boost of paying off your low debts first? Or is knowing you are saving hundreds or thousands of dollars in interest enough motivation? Whichever strategy you choose, the key thing is to stick with your goals and keep paying down your debts. Both strategies will lead to the same end result of zero debt. Check out this video which discusses one method to pay off your debt.