Debt can be overwhelming and alarming once it starts to build up. If you find that you have extra money and are deciding what to do with it, starting to pay off debts can be a good place to start. There are many different strategies and considerations for figuring out which debts to pay off first.
Debt Snowball Method
The debt snowball method entails paying off the smallest debts first regardless of the interest. This method is built on the idea that you have a certain amount of money that you are dedicating towards paying off debt each month. Minimum payments are made on the larger debts while you use the rest of your monthly budget for paying off debt on the smallest debt. Once you pay off the smallest debt, you attack the next smallest debt while continuing to make minimum payments on the others. It is called the snowball method because you are attacking the smallest debts, paying them off with more frequency, and gaining success in eliminating different debts more quickly. If the feeling of accomplishment some people get by paying off a single debt completely is important to you, then the snowball method has its advantages.
Highest Interest Method
Paying off the higher interest means that regardless of how much you owe on each debt, you pay the one with the most interest. The idea with this strategy is that you are saving money by eliminating the future accrual of interest. The more that you can apply toward the principal, the less interest overall you will have to pay. This method, however, may create less of a feeling of accomplishment in terms of paying of debts as soon as possible. The highest interest method puts more cash in your wallet in the long run by paying off the debts more quickly overall than the snowball method.
Not paying extra money towards debts
Another option could be to put money toward a savings account or investments for retirement. This money will pay you in the future over the long term rather than paying off debts that are costing you in the short run. The question here is whether the interest rate you are paying on the debt is greater than the likely rate of return on an investment. If it is, you will probably be better off paying off the debt rather than investing the money.
Also, you should consider whether the interest paid on a certain debt is tax-deductible, such as interest from education loans.
Judging by your credit score
If you are saddled with multiple credit card debts, investing in your long-term credit score could be beneficial. This is especially true if you plan on utilizing your credit for a house or car loan in the near future. Paying off credit cards with the biggest balances relative to your credit limit will help to improve your score.
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