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Debt Strategy: What do you pay off first?
Published: 03/31/2009
Debt Strategy: What do you pay off first?
Paying down your debt can be a great tool to help you stay on track financially, especially when the economy slows. But how do you know which debts you should tackle first? Where do you put your extra money each month so that it will make the most difference? Below we've provided a few tips to help you prioritize your debt pay-off strategy.
Priority #1: High-interest rates
No matter if you have a little or a lot of debt, you'd probably rather spend your money on something besides huge interest fees every month. That's why most financial experts agree: face those balances with the highest annual percentage rate (APR) first. This tactic can save you money in both the short- and long-term.1
The strategy is simple: Pinpoint one high-interest account until it's paid off, then move onto the debt with the next-highest interest rate. And repeat.
Priority #2: Small balances
Removing a bill or two from the monthly pile can free up at least a few more dollars a month fairly quickly. So if you have several balances that are small, consider paying those off at the same time you are paying down the high-interest rate accounts.1 Taking care of those easy-to-address, lower balances can give you additional encouragement because you'll see results right away.
Priority #3: Secured debts
Secured debts are those that are backed by some sort of asset, such as your home or automobile. Unsecured debts, such as credit cards, are not tied to any asset as a basis for the loan. Secured debts tend to be for larger sums of money than unsecured debts, meaning you likely will be paying interest on these types of loans for a longer period of time than smaller, unsecured debt amounts.
That's why making extra payments on a secured debt like your mortgage has the potential to really work in your favor. By making additional principal payments, you may be able to pay off your loan faster - shaving years off your loan term - and helping you save hundreds or even thousands of dollars on interest payments down the road. Plus, if you pay off your mortgage early, that gives you more money by the end to invest in things like retirement or other savings accounts.