Which Loans to Pay Off First?

When you're tired of being in debt and you're ready to develop a serious plan to pay it off once and for all, you have several options at your disposal. Some financial experts prefer the snowball method and some prefer the avalanche, but either way, it's still snow, and you'll be debt-free at the end.

First Things First

Gather all your loan information, from your credit cards to auto and home loans. Make a list of each debt with the following information: creditor, balance, minimum payment, interest rate and creditor's telephone number. Grab your telephone and start dialing, beginning with the high interest credit cards first. Ask your lenders to reduce your interest rates; customer service may be able to do this quite easily over the phone. Write down the new rate, along with the new minimum payment, if there is one.

Auto and home loans require more legwork, although it's worth investigating if you are paying high interest but also have a lot of equity. Make certain that you don't "cash out" any of this equity; that will keep transaction costs low.

The "Snowball"

Debt guru Dave Ramsey supports the "Snowball" debt reduction method, which instructs consumers to use every extra cent to pay off the smallest debt first, regardless of the interest rate, while only paying the minimum payments on the others. Once the first debt is paid off, that payment is applied to the next-smallest loan, continuing in this manner until all of the debts are paid.

The idea behind snowballing is that the early payoff success will provide enough gratification to continue on the program until all the debts are paid. However, be advised that this method may take longer. You also are likely to pay more in interest charges.

The "Avalanche"

Practitioners of the "Avalanche" use a similar approach, but with an important distinction: They pay the highest interest debt first, regardless of the amount or the loan term, because less is paid in interest and the loans are paid back more quickly. Mathematically, they are correct; however, it may be difficult emotionally if your highest interest rate loan also has a high balance, because it could be years before you pay the debt in full and move on to the next loan on your list.

Avalanche devotees say that they use benchmarks to stay motivated, such as noting the first $1,000 principal reduction, then $5,000, then $10,000.

Know Thyself

If your goal is to pay off your debts as quickly as possible while paying the least in interest fees, then the avalanche is for you -- provided you can keep yourself motivated. If you're an aficionado of instant gratification, then use the snowball. Either way, your debts will be paid. You must decide how you'll best stay motivated, because paying off debts can take several years.

If you are in over your head and need financial counseling, consider calling the National Foundation for Credit Counseling. This reputable nonprofit will walk you through your options.

Either way, just remember two simple tips: Ask for interest rate reductions first, and don't incur new debt while paying off the old.