Figuring out how to prioritize debt repayment can be tough. If done incorrectly, it could cost you thousands of dollars or more. Not to worry though, we’re here to help at Better Money Club.
Before we get started with the nuts and bolts of prioritizing your debt repayment, I think it’s important to take a moment and acknowledge the fact that times are hard. There should be no shame or stigma in getting into debt. Every aspect of life is exponentially more expensive than they were in our parent’s generation (no matter how old you are). That goes for food, transportation, housing, education, childcare, and everything else you can spend your hard-earned money all. Remember to cut yourself some slack.
I commend you for taking the difficult steps toward a better financial future.
It’s also important to mention another seemingly obvious thing: don’t go deeper into debt. There should be no reason to ever go deeper into debt if the goal is to get out of debt. Don’t borrow money to pay back money. There’s an old saying that says if you find yourself deep in a hole, the very least you can do is put the shovel down.
Commit to no more debt.
That goes for credit cards, new car loans, buy-now pay-later services like Affirm. No new debt of any kind. Once that’s done, you can take your first small breath in knowing that you have at least put the shovel down and will not dig that hole any deeper.
Now, we just need to cover one more thing before we get into what I consider the best method of tackling how to prioritize debt repayment. You need to make sure you know all your outstanding debts, even that phone bill from six years ago that you forgot about. The only way to do that is by pulling your credit report. Anything short of pulling and reviewing your credit report means that you can’t be absolutely sure there is no debt out in your name.
Now we’re ready to dive into how to prioritize debt repayment
There are many debt repayment techniques out there that have become popular over the years. The two biggest might be Dave Ramsey’s Debt Snowball method and the equally popular Debt Avalanche method. Both are great.
With the snowball method, you make minimum payments on all your debts to keep them current, then aggressively attack the smallest debt with all available excess money until it’s paid off. You work your way up from the smallest to the largest until all debt is paid off. The obvious issue here is that you end up paying more money in interest. The benefit is more psychological, betting on the fact that most people will keep it going after achieving faster wins and watching debt balances go to zero more often. Can’t argue with the results, either. The snowball method works for many, many people. But this is not the method I would recommend.
As for the avalanche method, it’s similar to the snowball method in approach, except instead of paying off the smallest debts first, you pay off the highest interest debt first. This maximizes the amount of money wasted on interest. The pure mathematical benefits of this method appeals to many people, myself included if I’m honest. But many people tend to struggle with staying motivated as the number of outstanding debts will likely stay open longer. There are likely no quick winds with this method.
The method I would recommend paying off your debt is similar to the avalanche method, working your way down by paying the highest interest debt first. The main difference between my method and the avalanche method is focusing on the debt of highest consequence first. Not all debt will have the same impact on your life if left unpaid. I would advise to always pay off debts of highest consequence first. Or, to put it another way, attack the debt that can do you the most harm first.
Pay off any debt that can cost you your freedom, your home, or will cause you harm.
After all high consequence debt is gone, the other debts should be paid off in order from highest interest to lowest. So, what are some examples of high consequence debt? Well, the biggest is probably taxes. If you owe takes, especially federal taxes, this should go straight to the very top of the list. One way or the other, the IRS will get its money. The IRS is the one authority that can not only garnish your wages, but take your freedom away. Plenty of people, from celebrities down to regular people, end up spending years in federal prison for failure to pay their taxes. Always remember, Uncle Sam gets paid first, always.
The IRS sits at the top of even the high consequence debt category. But after the IRS gets their due, I would lump all other High Consequence debt into the same priority level. Some examples include HELOCs, property taxes, 401K loans, student loans etc. The idea here is all of these types of debt can have devastating consequences on your financial wellness if neglected. Some will even stick to you after bankruptcy.
Here’s how I would recommend approaching debt repayment:
#1 First, make minimum payments on all debt to stay current and protect your credit rating.
#2 Any excess money should go toward paying down high consequence debt first except student loan debt (federal taxes at the very top of the list).
#3 Pay off all other debt in order from highest interest to lowest. Defer any payments already in collections.
#5 Pay off debt in collections. Look to settle if possible.
#6 Pay down student loan debt last.
So, there’s an obvious question you might have after seeing this order. Why pay off student loan debt last, especially if I put this debt in the High Consequence category? Unfortunately, the answer is a matter of practicality. Some student loan debt is as high as some mortgages these days, often getting well into the six figures. To maximize overall financial wellness, I recommend doing everything possible to keep your student loans current. Once all other debt is paid, knocking down this debt should be the priority.
There is also another thing it might be important to cover, regardless of the debt repayment approach chosen. What do you do if you can’t afford the minimum payments? There is a whole lot to cover on this topic, but I would strongly recommend against bankruptcy as an option. That should be an absolute last resort. For most people, bankruptcy is not necessary. The best option for most people in most situations is probably debt consolidation. But even in these situations, make sure you pay down that High Consequence debt.
Times are hard these days. Getting deep into debt is something that can feel all-consuming in your life. Often, we feel overwhelmed and unsure where and how to prioritize debt repayment. If you’re in this situation, keep your head up and arm yourself with the techniques in this article.
