Knowing your priority debt payments will make debt freedom easier to accomplish. The idea is to pay off the minimum on the other debts and focus all your extra money on this one. The chances of quickly getting rid of the top debt will be higher.
When you have multiple debts, it can sometimes make you feel confused. Monitoring a lot of credit accounts at once feels overwhelming. It is an unnecessary feeling – especially if you know that you have the income to pay it all off. But you cannot help but feel stressed about it simply because you have to multi-task.
According to reports, 6 out of 10 Americans said that their heavy debts are causing them a lot of stress. It is also said in the same report that despite the stress they are feeling, they are also optimistic about everything. They know they can pay it off. Maybe not immediately, but they are positive that they can completely pay all their debts.
If you want to have the same confidence, you need to start by identifying your priority debt payments. This will force you to go through all your debts. It will give you an overview of your current debt situation and the gravity of the financial problem that you have to overcome.
When you have this knowledge, you will feel more in control. Knowing the extent of the problem will allow you to come up with the best solution.
It’s important to realize that people deal with debt differently. They have various preferences when tackling problems. So do not think that what works for someone you know will work for you. To find out your specific style of debt relief, start by identifying the debt payments that you consider as your priorities.
3 options to determine your priority debt payments
Did you know that 2 out of 10 Americans use between 50% to 100% of their monthly income to pay off their debts? It’s no wonder that it’s causing consumers a lot of stress. With the average debt being $38,000 or higher, you need to succeed in paying off your debt completely. This is a huge amount of debt to overcome. You want to make sure that you will succeed. To make the chances of succeeding possible, start by determining your priority debt payments.
To illustrate this better, let us assume you have 5 different debts with the following details.
- Debt 1: Mortgage, $150,000, 4% interest rate, no credit limit
- Debt 2: Student loan, $15,000, 8% interest rate, no credit limit
- Debt 3: Personal loan, $2,000, 5% interest rate, no credit limit
- Debt 4: Credit card debt, $3,000, 20% interest rate, credit limit of $15,000
- Debt 5: Credit card debt, $7,500, 25% interest rate, credit limit $10,000
There are three ways for you to rank your debts according to priority.
This involves ranking your debts according to balance – specifically the lowest one. This is also called the debt snowball strategy. Based on the credit account samples above, your priority debt payments will be ranked as Debt 3 ($2,000), Debt 4 ($3,000), Debt 5 ($7,500), Debt 2 (15,000), and Debt ($150,000). The idea here is to get an immediate win. You will pay the minimum on all the other debts and focus all your extra money on Debt 3. Since it has the smallest balance, it is almost certain that you will pay it off immediately – maybe within a couple of months.
Once you have completely paid this off, it will make you feel good and motivated enough to pay off the rest.
By interest rate
In this option, your priority debt payments will be ranked according to the account that has the highest interest rate. Debt experts also call this the debt avalanche method. Looking back at the sample credit accounts, the ranking of the debts will be as follows: Debt 5 (25%), Debt 4 (20%), Debt 2 (8%), Debt 3 (5%), and Debt 1 (4%).
If the first option will help you get immediate success, this one will help you save money. In this case, paying off the high-interest credit cards is the best solution. It will take a bit longer to completely pay off the first debt. But the amount you will save will be bigger.
By credit limit
This is not a common option when it comes to determining priority debt payments. But it will also benefit you if you have certain financial goals in the future. In this method, you will be prioritizing the debt that has a balance that is closest to the credit limit. So if you base it on the credit accounts mentioned, the ranking will prioritize Debt 5 (balance of $7,500 and credit limit of $10,000) and Debt 4 (balance of $3,000 and credit limit of $15,000). The other three do not have a credit limit so you can choose if you will rank them according to balance or interest. If, for instance, you want to save money, the rank will be Debt 2 (8%), Debt 3 (5%), and Debt 1 (4%).
In this option, you are trying to improve your credit score fast. It is ideal if you want to condition your finances to tackle another financial goal. All the other options will improve your credit score as long as you stick to your payments. But if you need immediate improvement, then this is the best method to follow.
Why is it important to determine the priority debt payments
The truth is, it is not just about paying off the debt. You want to find your priority debt payments because you want to set up your future too. Paying off the debt is necessary but you want to hit two birds with one stone by making sure you are still going where you want your financial future to go. Once you get out of debt, you don’t want to start from square one. You want to be poised and be ready to take on your next financial goal. There are many strategies to pay off your debts fast. At least one of these options will help you get to your goal faster.
Choosing the priority debt payments can depend on what you want to happen.
If you want an immediate win…
In case you want to stay motivated in your debt relief option, then you should choose your priority debt payments based on their current balance. The lower the balance, the higher it should be in the ranking. When you focus on the smallest balance, this will be paid off faster. That will give you the encouragement that you need to continue with the rest. Before you know it, your one debt away from debt freedom.
If you want to save more…
If saving money is more important to you, then you need to rank your debts according to the highest interest. One of the ways for you to save on your debt payments is to eliminate the high-interest debts first. The longer it takes to pay off a debt, the more you end up paying towards the interest. So let the low-interest debts stay in the backseat for now.
If you want to improve your credit score…
Considering the credit limit will allow you to work on improving your credit score faster. For instance, if you want to buy a car in 12 months, then having a better credit report will help you get better terms on the loan. The same is true if you want to apply for a mortgage. Focus on the credit limit to raise your score through the credit utilization rate.