Friday, May 20, 2022

Which Loan Should I Pay Off First

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Finding A Balance That Works For You

Which Student Loan Should I Pay Off First?

The problem for many Americans is that their debts are so significant compared to their monthly income that it will take many years to pay the balance down to zero. While it might be tempting to simply postpone saving while youre paying off debts, that often isnt a realistic option. Even families with high debt want to be able to purchase a home, have a child, pay for college or provide support for ailing loved ones and that requires substantial savings.

The key, then, is to find the balance that works for you and your family, agree on a plan and stick with it. Our recommendation is to prioritize paying down significant debt while making small contributions to your savings. Once youve paid off your debt, you can then more aggressively build your savings by contributing the full amount you were previously paying each month toward debt.

Sticking With The Plan

Regardless of which debt repayment strategy you choose, the key to success is sticking with it. Once you decide on a payoff plan, its helpful to map it out on your calendar so you know when each one will be completed. This allows you to keep track of your progress and it also keeps you motivated to reach the next target on your list.

Giving yourself a small reward every time you pay off a debt provides a much-needed boost. Have a friend or your spouse act as an accountability partner can help you stay focused. With a little patience and perseverance, youll be doing the debt-free dance before you know it. Paying off credit card debt is tough but worth it.

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Alternative Methods Of Managing Mounting Debt

Sometimes, individual borrowers may struggle in situations where they simply cannot repay their mounting debts. A lack of financial means, serious illness, and a poor mindset are some of the reasons this occurs.

In the U.S., borrowers have alternative methods that can salvage their situations. They should carefully weigh these options and assess in detail whether they should use them or not, as many of these methods may potentially leave borrowers worse off than before. Higher costs, lower credit scores, and additional debt are some of the possible consequences. For these reasons, some personal financial advisors suggest avoiding the options listed below at any cost.

Debt Management

Debt management first involves consulting with a credit counselor from a credit counseling agency. The U.S. Department of Justice contains a list of approved credit counseling agencies by state.

Suppose they deem a debt management plan viable. In that case, the credit counselor will extend an offer to the debtor. The agency will take responsibility for all their debts every month and pay each of the creditors individually. In turn, the agency requires the debtor to make one monthly payment to the credit counseling agency and possibly other fees. Usually, credit counselors will also require debtors to avoid opening new lines of credit and close their credit cards to avoid accruing new debt.

Debt Settlement

Bankruptcy

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Consider The Snowball Method Of Paying Off Debt

This involves starting with your smallest balance first, paying that off and then rolling that same payment towards the next smallest balance as you work your way up to the largest balance. This method can help you build momentum as each balance is paid off. Understand the pros and cons of this debt pay down strategy by reviewing the Snowball versus Avalanche methods of paying down debt.

Choosing Your Debt Payoff Strategy

Which Student Loan Should I Pay Off First?

Experts tend to fall in competing camps over what debt payoff strategy works best.

The debt avalanche approach is when you first focus on paying off the debt with the highest APR . Then, once that is paid off, you move onto the card or account with the next-highest APR. This method results in the most amount of money saved in interest, and generally, this method prioritizes credit cards and personal loans over student loans, which often have the lowest interest rates of any type of debt.

Paying off debt with the highest APR or balance first is also a good way to help your credit utilization ratio, says Jennifer Streaks, personal finance expert and author of the book, Thrive!Affordably. If your credit card limit is $3,000 and you have a $2,500 balance, it will hold back your credit utilization ratio, which indicates how much of your available credit youre using. It makes it look like youre not using credit responsibly, Streaks says.

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How To Use The Debt Snowball Strategy

Heres an example of the debt snowball strategy in action:

Lets say you have three debts:

  • $400 medical bill $40 payment
  • $2000 credit card debt $54 payment
  • $3,000 personal loan $90 payments
  • The wisest thing to make the debt snowball method work optimally is to create a second income from a side hustle, such as mowing lawns, starting an online business, or even babysitting. You can find many hacks to save money or make extra money at home to support you and your family. If you have an additional $400 a month, you could pay off the medical bill in one month.

    Now you take the $400, plus the $40 payment you were spending on the medical bill, and apply it to your credit card debt. In about four and a half months, that credit card bill will be gone.

    That snowball is growing now. Youve eliminated $2,400 in total debt and freed up $94 a month for your budget . You can now use your $400 extra income plus $94 and apply it to your personal loan, which youll pay off in about six months.

    In this scenario, youd be debt-free in less than a year.

    Admittedly, were using small balances in this example to illustrate how the strategy works. But this method works whether you have three debt accounts and $5,400 in debt, or 10 times that debt.

    What Others Are Saying About Paying Off Debt

    We looked around the web and decided to include a debt payoff method used by many people. It is referred to as the debt snowball method, and according to Wikipedia, it works like this:

    The basic steps in the debt snowball method are as follows:

    • List all debts in ascending order from smallest balance to largest.
    • This is the methods most distinctive feature, in that the order is determined by amount owed, not the rate of interest charged. However, if two debts are very close in amount owed, then the debt with the higher interest rate would be moved above in the list.
  • Commit to pay the minimum payment on every debt.
  • Determine how much extra can be applied towards the smallest debt.
  • Pay the minimum payment plus the extra amount towards that smallest debt until it is paid off.
  • Note that some lenders will apply extra amounts towards the next payment in order for the method to work the lenders need to be contacted and told that extra payments are to go directly toward principal reduction. Credit cards usually apply the whole payment during the current cycle.
  • Once a debt is paid in full, add the old minimum payment from the first debt to the minimum payment on the second smallest debt, and apply the new sum to repaying the second smallest debt.
  • Repeat until all debts are paid in full.
  • You can find more information about this at Debt snowball method.

    Do you have a method that helps you pay off debt? Please leave us a comment.

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    How To Pay Off Debts Early

    Once borrowers decide to pay off debts early, they may struggle to act. Achieving such a goal often takes firm financial discipline. Finding extra funds to pay off the debts usually involves actions such as creating a budget, cutting unnecessary spending, selling unwanted items, and changing one’s lifestyle.

    Borrowers should also use the right strategies to pay off their debts. Listed below are some of the most common techniques:

    Debt Avalanche

    This debt repayment method results in the lowest total interest cost. It prioritizes the repayment of debts with the highest interest rates while paying the minimum required amount for each other debt. This continues like an avalanche, where the highest interest rate debt tumbles down to the next highest interest rate debt until the borrower pays off every debt and the avalanche ends.

    In other words, a credit card with an 18% interest rate will receive priority over a 5% mortgage or 12% personal loan, regardless of the balance due for each. The Debt Payoff Calculator uses this method, and in the results, it orders debts from top to bottom, starting with the highest interest rates first.

    Debt Snowball

    In contrast, this debt repayment method starts with the smallest debt first, regardless of the interest rate. As smaller debts get paid off, the borrower then directs payments toward the next smallest debt amount.

    Debt Consolidation

    Paying Off Loans With Credit Cards

    Which Student Loan Should I Pay Off First?

    Are you disciplined about repaying what you borrow and have a good credit score? Then there are occasionally interest-free or low-interest balance transfer credit card deals which transfer money directly into your bank account.

    These can then be used to repay overdrafts and loans.

    However, these deals usually come with a fee. So youll need to work out whether doing this would be cost-effective for you.

    Make sure youll be able to pay off what you owe on the card before the zero or low interest rate runs out. And ask your personal loan provider how much it will cost to pay off the debt in full.

    Read more about 0% money transfers on the MoneySavingExpert website

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    How Can I Pay Off My Student Loans Faster

    While the avalanche method or snowball method can certainly help you pay off your student loan debt faster, there are also other approaches you can take if youre looking to eliminate student loan debt as quickly as possible. Enrolling in automatic payments can ensure that you never fall behind on payments and that you stay on schedule because otherwise, falling behind can slow down the repayment process. Biweekly payments, if feasible, can also make it easier to pay off student loans faster. If youre paid biweekly, consider setting aside a fixed amount from each paycheck and putting it toward your student loan debt.

    However, paying off student loans early may not be for everyone. There are a few instances where you may want to spend extra money elsewhere instead of on your student loans:

    • Remember to start an emergency savings fund that is equivalent to 1-3 months of expenses.
    • Start saving for retirement early and contribute to a 401k or a Roth IRA if its available to you through your employer.
    • Stay on top of credit card payments as they often have the highest interest rates.
    • Enjoy life without dedicating all of your time, money, and energy to repaying your student loans. You can set aside funds for an affordable vacation or save a little extra money for a nice dinner out at a restaurant.

    Use Math To Determine Which Debt Will Benefit You The Most To Pay Off

    Paying off debt with a high interest rate before anything with a low interest rate will allow you to save money in the long-run. Paying $500 towards a loan with an 18 percent interest rate will be far more beneficial than paying $500 towards a loan with a 5 percent interest rate.

    Paying off a debt with a higher interest rate first may not be the best priority every time, though. You may want to consider targeting debts with lower balances. This can serve two purposes first, it frees up money to direct towards other debts, and second, it feels pretty great to pay off an account. Dont discount the mental boost you can get from clearing a few of your smaller debts away before focusing on the big ones.

    When determining which of these debts to pay off first, consider all factors. What is your interest rate? How much will you end up paying if you take longer to pay it? And can it be paid fairly quickly if you focus on that debt above others?

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    Good Debt Vs Bad Debt

    Debt can take many different forms. Understanding the difference between good debt and bad debt can influence your repayment strategy. Generally, good debt is anything that has a relatively low-interest rate and is secured to some to the type of property. Home loans, for example, are typically considered good debt since youre buying ownership into something tangible. Student loans could also qualify as a good debt since they tend to carry relatively low-interest rates and youre investing in your education.

    Bad debts generally arent tied to any property and they tend to carry much higher interest rates. Credit cards, payday loans, car title loans and high-interest unsecured loans could all be considered bad debts. If you owe a mix of both good and bad debt, you want to make sure that you pay off the ones that are costing you the most money first. Once you ditch the bad debts, you can toss the extra money towards the ones with lower interest rates.

    S To Figure Out Which Debts To Pay Off First

    Which Student Loan Should I Pay Off First?

    If youre struggling to decide which debts to pay off first, here are a few steps that might be able to help:

  • Consider the higher interest rate. In general, paying off your debts with the highest interest rates first can help you save the most money in the long run.
  • Check the tax advantages. The IRS allows you to deduct interest paid on specific types of debt like student loans and mortgages though how much depends on your income and tax regulations. Look into the tax benefits of each of your debts to see where you stand to save the most by making extra interest payments.
  • Understand the risks. Secured debts like mortgages and car loans pose more risk should you default since the lender can repossess your property to recoup its losses. You might want to focus on making extra payments on those debts first rather than unsecured debts, like student loans and credit cards.
  • Compare your repayment options. Consider how flexible your repayment options are with each type of debt. Federal student loans and some personal and car loan providers allow you to pause repayments if you hit a financial rough patch. In this case, focusing on paying off your debts with less-flexible repayment options might make more sense.
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    Mortgages and student loans are generally considered good debt. And theyre usually hefty the average borrower has tens of thousands of dollars in student loans and around $200,000 sunk into a mortgage.

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    Option : Consolidate Your Debt

    Key advantages: You could receive a lower interest rate, simplify your finances and repay your debt faster.Key drawbacks: There could be up-front costs and theres a chance you may not qualify for a lower interest rate.Best for: People who are making multiple monthly payments with high APRs.

    If you want to consolidate your debt into a single monthly payment, you have a few options. You could transfer your existing credit card balances onto a balance transfer credit card, many of which come with lengthy 0 percent introductory APR periods. The top balance transfer credit cards offer between 15 and 21 months of 0 percent APR on balance transfers, giving you ample time to start paying off your debt without paying interest on your transferred balance.

    You could also take out a personal loan and use that money to pay off high interest debt. Yes, youll still need to pay off your personal loan, but if you can find one that offers considerably lower interest rates than what youre currently paying, it might be a way to lower the overall cost of your debt repayment process. Use Bankrates debt consolidation calculator to figure out how much you could save by taking out a personal loan.

    Sign up for a Bankrate account to analyze your debt and get custom product recommendations.

    Debt By Balances And Terms

    While the debt avalanche method might save you more money, you may be better off using the “debt snowball” method. Rather than focusing on interest rates, you pay off your smallest debt first while making minimum payments on your other debt. Once you pay off the smallest debt, use that cash to make larger payments on the next smallest debt. Continue until all your debt is paid off.

    The debt snowball method is a good strategy if you respond well to little victories and dont have the patience to tackle big balances first.

    If you have a small debt, like a few hundred dollars, you might be able to pay this off in a few weeks or a couple of months. This first win may be the motivation you need to stay the course and pay off your remaining debt.

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