What debt should I pay first? Explained with examples!
Most people who have debt want to get out of it, but this is a very delicate task. One of the most common questions that people ask themselves when they decide to face their debt is where to start. After all, all financial situations are different, making this question difficult to answer in simple terms.
If you have a debt, maybe a single credit card or a personal loan, the game plan is quite simple. After budgeting for your basic expenses (rent, utilities, basic grocery needs), look at how much extra money you can allocate to pay off your entire credit card and not install the bill more. Or you can simply take out a smaller interest loan to pay off the card debt and pay less interest on the loan.
With two or more debts, things can be more complicated. The easiest way to get started is by making a checklist to determine which debts need your most attention. People have to prioritize their debts for two reasons: they may not be able to make all the minimum payments they have and must choose which ones to pay or want to pay more than the monthly payment because they want to be free of debt as soon as possible. What, then, should be done? Let’s go step by step.
Categorize your debt
There are two types of debt: secured and unsecured. Secured debt means that there is an asset linked to the loan, such as a home or a vehicle, that the lender can recover if you do not pay the agreed upon. Secured loans often come with lower interest rates than unsecured debt because the lender has something of value to take if the bills are not paid.
Let’s say you have a loan for a vehicle and a large amount of credit card debt, and you can not afford to pay so much. Prioritize secured debt (vehicle loan) because if you do not pay, you will lose your car, which could prevent you from getting to work, jeopardizing your work and costing you the income you need to pay any of your accounts.
If you can repay your debt, but just want to get rid of them, the opposite strategy makes more sense. Target unsecured debt because it generally has higher interest rates, and is often the type of debt that quickly gets out of control.
Home and vehicles are always in the foreground while personal loans and credit cards should be paid through loans with lower interest rates, debt renegotiation, portability of credit or other means that reduce your debtor balance as fast as possible.
Small steps, such as saving change coins and saving for debt repayments, can be great leaps toward a debt free life. (Photo: www.levo.com)
Always compare interest rates
If you are deciding between prioritizing the repayment of your credit cards, student loans and / or personal loans, an easy way to choose where to start is by looking at interest rates. If you can separate extra money from the budget for debt relief and direct that capital toward high interest debt (probably credit cards), you will probably make your debt stop growing.
Continue to make the minimum payments on your lower interest debt, such as student and personal loans, as well as paying the minimum installments on vehicle and real estate financing.
Again, if you’re prioritizing why you can not make all the payments, the strategy will be a bit different. Even though personal and student loan debt are lower, defaults on these loans have more serious consequences than defaulting on credit card debt. Before you begin choosing which accounts to pay, look for options and make a solid payment plan.
An example of what you can do: If you have a credit card that is charging you 20% interest per month, but you can take out a personal loan that pays your debt by charging less interest than the credit card, you must get the loan , remove the credit card and pay the installments of the loan on time. In some cases, you can even add other debts and focus them on a single, lower interest loan. This strategy we call debt consolidation.
There is also another strategy that is not so easy if you have secured financing. You start by paying off the highest interest debts and will only make the minimum payments on the remaining ones. If you have some secured financing, you will have to continue paying that financing, at least the amount of the normal installments. Once your highest interest debt is repaid, you move on to the second highest interest debt. We call this snowball strategy.
Decide what you want
If you have decided that you need to urgently withdraw your credit cards, you may have to prioritize even more. Some people recommend going directly to the balances with the highest interest rates, since you will save more money on interest. Others will tell you to choose the lowest balance.
Paying the card that has the lowest balance, even with lower interest rates, can be a good first step. Paying off that first debt will give you the motivation to continue getting out of debt. The difficulty in getting rid of large balances and high interest rates first can have the opposite effect: emotionally, it is like making a diet and not losing some weight during the first five years. You should give yourself the initial motivation towards a life free of debt.
However, if you can not bear the idea of letting interest rates of 20% of the card continue to grow while you deal with lower debt, you can take a more sensible attitude by going directly to higher interest debt. It’s all a matter of deciding what will make you feel better and give you the confidence you need to keep moving toward a hard-to-reach goal. Using snowball strategy or debt consolidation may be what you need to reorganize your finances and keep on track toward debt freedom.
Start making progress: make a budget!
Once you’ve started paying off your high priority debt, think about what your next steps will be, using the same process. Depending on how much you can devote to repaying your debt, you may face multiple balances at once. You can use this online calculator to see how much it will take for you to be free of credit card debt. Keep up to date along the way by reviewing your financial situation constantly. To do this follow up and prevent you from having your debts back, a budget with all your expenses and earnings must be made so that you have control of your financial life back.
There is no easy way to pay off debts, but one thing is certain: you must change the lifestyle that has brought you to this complicated situation and learn as much as possible with this debt lesson.
Have you ever had any debt? How did you get rid of her? What debts do you suggest that people get rid of first and why?