Having multiple debts is overwhelming for most people, which makes them look for ways to pay off the debts as quickly as possible. The strategy to get rid of debts usually considers repaying debts one by one.
However, most people don’t know how to distinguish the one priority debt that will be most favorable to pay off first. car title loans Houston experts have provided this article with advice on the aspects you should focus on for determining which debt you should knock off primarily.
The problem with depts is always their compounding aspect that open debts produce the longer they are active. This happens due to its interest rate ingredient. However, every financial situation is unique and requires individual observation and strategy.
Which debt should be paid off first depends on the borrowers’ financial capabilities, expenses, income, and other financial obligations they have. On the other hand, certain universals can be applied in identifying the debt that should be prioritized for paying off.
Prioritizing a Debt with The Highest Interest Rate
Debts with the highest interest rate are the ones that cost you the most money. Even though these debts might not be the ones with the highest principal amount, in the long run, the ones with the highest interest are the most expensive debts, while continuing to pay the minimum payments of your other debts.
Therefore, paying off the debt that has the highest interest rate will save you the most money and reduce the total cost over time.
After paying off your most expensive debt, you can proceed with this method to your second-highest-rate debt and continue the pattern until you pay off all your debts.
The debts with the highest interest rate are often credit cards and personal loans. Secondary rates with high interest are long-term rates such as student loans and home equity lines of credit and some car loans. The lowes interest rates usually consider the debts with the longest repayment terms such as mortgage loans and some business loans.
The method of prioritizing paying off the debts with the highest interest rate is also called avalanche debt repayment.
Prioritizing a Debt with The Smallest Balance
Contrary to the avalanche debt repayment method, there is a debt snowball strategy. On the opposite of prioritizing paying off the debt with the highest interest rate, this method focuses on paying the minimum monthly payments to all debts but directing the extra money to eliminate the debts with the smallest balance first.
After repaying the first debt, take the monthly money amount and join it in the second smallest balance minimum monthly payment, continuing with this practice with all your debts.
Making the largest payments on the next smallest debt creates the debt snowball effect. With this method, you can see the results more quickly.
This strategy is focused on motivation and momentum. Repaying the smallest balance first is the suitable solution for people that lack the motivation and discipline to stay on a course that the avalanche debt repayment method requires.
Prioritizing the Largest Balance Debt
Prioritizing the largest balance debt is not a popular method to start knocking out your debts. However, in some cases, this can be the best starting point in freeing yourself of debts.
Some largest balance debts can be considered as priority such as:
If your largest balance is in the 0% interest rate promotional period and you have to repay it before that period ends
If part of the balance has a higher APR due to specialized transaction types
If the largest balance is harming your credit score (if you are using more than 30% of the available credit limit)
Paying off the largest balance debt method usually considers eventually switching to snowball or avalanche practice after the largest balance debt is repaid.
Debt Consolidation
Debt consolidation can be the optimal option in circumstances when you are not capable to pay off your balance in the next five years or when all your debts have so high-interest rate which makes them impossible for you to repay them quickly and in a near future. These can be the reasons why debt consolidation is the appropriate solution.
Debt consolidation considers getting new financing that will pay off all your current debts.
In case most of your existing debts are credit card debts, you can consolidate those debts by using a credit card balance transfer.
On the other hand, if your debts are other than credit cards and exceed the amount of 5.000$, the solution might be a debt consolidation loan.
As mentioned indicates, debt consolidation implies paying off all your debt balances at once.
The advantage of debt consolidation is in minimizing interest charges applied to your previous debts. This way you can pay off the debt principles faster.
Prioritize the Debt with The Highest APR
This method is considered a cost-saving. APR is an annual loan cost. The difference between interest rate and APR is that the second includes other charges and additional fees such as loan origination fees, mortgage insurance, closing costs, and others. APR is demonstrated in percentages just like an interest rate.
Debts with APR tend to cost you more money each month because each month that you leave your balance with APR applied you have to pay for it. Or this reason, most financial experts recommend paying off debts with APR first, as they waste your money the most.
This type of debt payoff prioritizing is also known as the avalanche method, as it also provides quick acceleration.
Summary
Besides the mentioned criteria for prioritizing debt repayment, there are some debts that might not be as expensive as others but are causing us more financial and emotional stress. These debts might not have anything referring to the high-interest rates or balance but have a personal significance.
Hopefully, we have helped you comprehend the methods for prioritizing the debt to pay off first. However, as said before, debt prioritization depends on different aspects and might require professional consultations.
