Which Debt Should You Pay Off First?

April 28, 2010 - Kristin
We’d all like to be debt-free, but for most of us that would take a very long time and a lot of discipline. But even while we continue to diligently pay the bills each month, we can change the way we pay off each of our different debts to get closer to living the debt-free dream.
 
Ask yourself: What does your debt really cost you? Which types of debt may cost the most? Which ones are in your best interest to pay off more quickly?
 
Thinking about your interest rates and tax implications can help you prioritize.
 
Pay off your credit cards and auto loans first. These types of debt are likely to have the highest interest rates, and could cost you the most over time.
 
Pay off your credit cards and car loan in order of highest to lowest interest. Paying off a card with an 18 percent interest rate is like earning an 18 percent return on your investments. You could also try asking for a lower rate. It may actually work if you have a good credit record.
 
Student loans should come next. It goes without saying that you should at least pay what is due on your student loans each month, but keep in mind that you may be able to deduct up to $2,500 per year in student-loan interest from your taxes. When you’re ready to pay extra on your student loans, pay the highest-rate student loans first.
 
Tackle your home mortgage and home-equity loans last. Simply making your monthly payments on these loans might not be a bad strategy. If you have a low rate on a fixed mortgage and can steadily make your payments, you might achieve better results by investing the extra money rather than making extra mortgage payments. In addition, you may be able to deduct some of the interest on your mortgage from your taxes.

2 Comments:

  1. July 2, 2010 - Devo

    Good article but I would disagree with your priority by which one pays off debt. Yes, it would make the most sense to pay off the highest interest debt to lowest interest debt, however, debt is formed by bad habits which often has little to do with logic and common sense. If one had enough logic and control to pay off the highest interest rate debt first, then that same person would have had enough logic and control to not get into debt in the first place. Bad habits need to be overcome and emotion is a big part of it. Someone paying off debt needs a "quick win" so that he can see progress and be motivated to keep going. These emotional "quick wins" can happen if the debtor pays of his debt, smallest to largest. I highly recommend Dave Ramsey's philosophy and "7 Baby Steps" to getting out of debt.

    http://www.daveramsey.com/new/baby-steps/

  2. July 16, 2010 - stormyghost

    I agree with the comment. I had an equity line that was the same payoff as my car. I was trying to refinance and when my bank learned my focus was paying off my car loan (the higher interest rate/higher payment) instead of my equity line (lower payment/interest rate) they scolded me! They said you should always pay off your equity line and house loan first! If I had put the same amount of extra payments towards the equity line and not my car. Very frustrating and often conflicting information.

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