As with any other significant undertaking, paying off debt goes faster, smoother and with less stress when you have a plan. Approaching the problem in an organized fashion ensures nothing gets missed and could save you quite a bit of money besides. While there are a number of different ways to go about prioritizing your debt payments, the two outlined below have seen the most consistent successes.
Organization is Key
The first step is to get a firm grasp on whom you owe, how much you owe, the amounts of the minimum monthly payments and the interest rates being applied to those debts. You can get this data from the bills you receive each month.
By the way, you should be reviewing each of those statements carefully when they arrive. If you’ve opted for paperless statements, review them online before you make the monthly payments. Yes, looking at bills is a pain in the left foot (or perhaps a bit higher), but you need to know how much you owe and how your efforts to pay them off are progressing.
In some cases, you might even still be paying a bill that should have been paid off already, but is still registering as outstanding because of a mistake on the part of the creditor. Paying bills blindly is a surefire way to overpay.
Read your statements each month.
One more thing, in situations involving federally backed student loan debt, you might qualify for government programs designed to make repayment easier. Freedom Debt Relief’s advice about government debt relief programs can help you decide the best route to take in those instances.
Deciding Upon a Prioritization Strategy
Most people tend to divide whatever cash they have to deal with bills evenly among all of their debts and pay as much as they can on each one every month. As admirable as this is, it’s also one of the most expensive ways to pay off your debts. This is why prioritization is so important—particularly when you have debt trouble.
Here are two highly effective ways to prioritize your payments.
Interest Rate Prioritization – The most cost effective method is to rank all of your debts in terms of the interest rates being applied to them from lowest to highest. Make minimum payments on all of them but the one with the highest interest rate. That one will receive all of the money left over after minimum payments have been made on the rest.
To simplify the math, let’s say you have five debts of $10,000 each and their minimum payments are $100 monthly. You also have $2,500 to apply to them each month. Rather than paying $500 on each one, paying the minimum on all but the one with the highest interest rate will give you $2,100 to apply to that debt. All things being equal, you’ll have it paid off in four months. However, had you been paying $500 monthly, you would have needed 20 months to pay that bill off.
The next step is to take that $2,100 and combine it with the $100 you were paying on the next one in line; you’re now applying $2,600 monthly to a debt of $9,600 ($10,000 – $400 = $9,600). Four months later, that one will be paid in full. Continuing the process as you work your way toward the debt with the lowest interest rate will find all of your debts paid off in roughly 20 months. However, attacking the highest interest rates first eliminates them sooner, which means you’ll pay less interest in total to close out your debts.
Outstanding Balance Prioritization – This approach uses the same basic tactic. However, rather than focusing on the debt with the highest interest rate first, you’ll go after the one with the lowest balance.
Let’s say you have five debts with balances of $14,000, $10,000, $5,000 and $1,000. Once again, you have $2,500 to put toward them each month. The $14,000 debt has a minimum payment of $140, the $10,000 debt has a minimum payment of $100, the $5,000 debt has a $50 minimum and the $1,000 debt has a $10 minimum.
Again, rather than dividing the $2,500 evenly between them, make the minimum payment on all but the $1,000 debt. This will leave you $2200, which will pay it off immediately and give you $1,250 to apply to the $5,000 balance that same month. The following month, you’ll have $2,250 to apply to a balance of $3,750. Continuing this pattern, you’ll have that $5,000 paid off in three months.
Continuing in this fashion, the higher you go in the order, the more money you’ll have to apply to each debt and the sooner you’ll pay each one in full.
Which is Best?
Saving money is always a good thing. On the other hand, seeing progress has motivational advantages. Per our examples, going after the lowest balance first delivers immediate progress, which spurs you onward. Meanwhile, the interest rate method might take longer to show tangible results, but would result in less cash out of pocket.
Ultimately, it comes down to immediate gratification, vs. long-term gain. It’s your choice. Either way, prioritizing your debt payments in either of these fashions will help you get out of debt sooner than paying all of them equally.