It's easy to rack up debts without thinking about how much debt actually costs and how long it takes to pay off balances. Not having a debt-management plan can lock you into paying high-interest credit cards and loans for years. At times, it may be worthwhile to abandon conventional wisdom about savings and investments to reduce a debt load.
Credit Cards
The order in which you pay off credit-card debt can help you save money in the long run. There's more immediate gratification in paying off the card with the lowest balance first because you can get to a zero balance faster. However, you'll save more money by paying off the card with the highest interest rate first. Credit cards can have interest rates that exceed 20 percent, and people who've had past credit problems could be paying rates that are closer to 30 percent. The longer such high rates accrue on your credit-card balance, the harder it's going to be to pay off the debt.
Tax-Deductible Debt
Some people pay more than the required monthly payment on mortgages and student loans for the satisfaction of watching the balances on these typically large debts drop quicker. However, paying down those loans before paying off credit cards, car loans and other high-interest debts may not be the best option, reports MSN Money. Mortgages and student loans usually have lower interest rates than credit cards and car loans. Furthermore, the interest paid on home and student loans is often tax-deductible, which allows borrowers to recoup some of their costs. Consumers should focus on paying off high-interest, nondeductible debt first.
Minimum Payments
It's worthwhile to make more than the required minimum payment each month if you can't afford to pay off a high-interest credit card or loan. Your goal should be to pay off high-interest debt as soon as possible. Bankrate.com and other websites provide calculators that can give people a reality check about making low monthly payments on credit-card debt (see Resources). For instance, it would take 20 months to pay off a card with a $500 balance and a 19-percent interest rate if you made a monthly payment of $30. Yet the card would be paid off in nine months if you increased the monthly payment to $60.
Debts vs. Savings
Financial professionals often advise consumers to save money for emergencies. That's sound advice, but some financial experts note that it may be wise to cash out savings or investments to pay off high-interest debts. For example, a person's investments would have to pay out 18 percent before taxes to match the money being paid out on a debt with a 12-percent interest rate, reports The Motley Fool. Savings accounts especially don't provide such high returns. While savings and investment accounts don't offer guaranteed returns, consumers are guaranteed to save money by paying off high-interest debts.
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