Molly’s Money: How do you prioritize which debt(s) to pay off first?
I’m back with another edition of Molly’s Money!
It’s been a few weeks since my last post and I wanted to get back into things with another reader question. If you’re new here, Molly’s Money is a financial series of blog posts that I write semi-weekly talking about ALL things personal finance. It all stems from my journey of becoming debt free and so here’s where I talk about what I’ve learned over the years in the hopes that someone won’t make the same mistakes I did. OR maybe it’s just for that someone who is in the same position I was.
So, this week’s question is:
“How do you prioritize what debt(s) to pay off first?”
This is an AWESOME question and one that I get A LOT. For anyone who has ever been in debt and struggled to climb your way out if it, this first step is often the hardest. Sometimes it’s like you have this mountain in front of you and you have no idea how you’re going to get over it.
Except the answer is always the simplest: one step at a time.
So, you have this mountain of debt and you’re overwhelmed and you don’t know what to pay off first. Well, there are a couple factors at work here that will lead you to the right answer.
When you’re in debt, the FIRST step is to figure out what kind of debt you’re dealing with. I’m not going to answer that question here because I’ve already answered it in a post before which you can read here.
Now, if you’re going the debt consolidation route, your debt, literally, gets consolidated so the answer to “What to prioritize?” pretty much gets answered for you.
But, if you’re in a manageable amount of debt figuring out what to pay off first can be tough.
If you’ve ever listened to Dave Ramsey, you may have heard of the “Debt Snowball.“
This is definitely the method that I recommend.
Basically, the debt snowball is the method of starting with the SMALLEST debt and working your way up to the LARGEST debt.
So, basically, in a nutshell the debt snowball works like this:
- You list your debts in list of smallest to largest (taking interest rates into account, too)
- Start with that smallest debt and attack it like you’ve never attacked anything before. Put EVERY dollar you can into paying off that smallest debt. ALL the while, paying the minimum payments on every other debts. Do not, and I mean DO NOT ignore your other debts when you are paying off that smallest debt.
- Once you’ve paid off that smallest debt, go to the next one and so on and so forth.
So why start with the smallest?
The truth is, it’s all a mental game. Think about it, if you spend all this time working at that largest debt and it takes forever to pay off, you’ll start to feel frustrated and tired and you’re more likely to give up on your plan than to finish the job.
BUT, if you start with that smallest debt and pay it off, and then pay the next one, and then next one, and so on and so forth, you’ll feel a sense of accomplishment. Those little “wins” are motivating and will only energize you to keep paying off the debt.
Know what I mean?
What about you? Have you heard of the debt snowball? Have you tried this technique? Are you in debt and plan on trying this method? Leave your thoughts, other questions, and feedback in the comments below!
I really like this concept! Last year I said no to, oh, just about everything. The result was that I was able to pay off all of my debt that existed outside of my student loans (somewhere between $8000-$10,000, depending who you ask). I even sold my car once I moved off the metro line in december, because I realized it was a small price to pay to be more financially stable.
I have to say, I’ve been kinda lazy since I got down to just student loans, but this post is making me want to attack my student loans the way I did the rest of my debt. Thanks for sharing!
that’s AWESOME, patrick! way to go for making serious sacrifices! it will TOTALLY pay off in the end… literally!!
Oh my gosh… I never thought of it that way but you’re right! I’ve been putting so much energy into paying off te credit card with the largest amount of debt and the smaller one has just been sitting there patiently (I still make payments just not as high). But it makes SO much more sense in so many ways to pay off that smaller one first!
yay! i’m so glad this was helpful for you, niki!
I think it’s important to that really, the most important thing about the Dave Ramsey method is to be CRAZY INTENSE about paying off your debt, even if you decided to not pay the smallest and instead the highest interest rate first.
However I also wanted to point out that different debt has different possible outcomes. (Consider that when prioritizing) Student loans should generally be attacked AFTER all credit card debt, no matter the interest rates. As my sister pointed out, student loans usually always have ways of working with you. Either changing your payment plan, or deferring for various reasons (including unemployment) . And, when you think about it, they can take away your car if you dont pay the loan, but they can’t take back your education!
P.S. School loan debt is forever until its paid. Even bankruptcy won’t eliminate it!
absolutely, erica!! being diligent is the most important part!!
Great post Molly! I love Dave Ramsey! My mom took me to go see him when he came to Houston a couple years ago and I’ve been on his plan ever since! Right now I’m on step 2 – the debt snowball…which I will be on for eternity, but it’s so rewarding to really focus and get things paid off!
thank you so much, miranda!! that’s awesome!!!! keep it up!
I know the debt snowball may not technically be the “smartest” way since I guess you should really pay down your highest interest rates first, BUT I think the debt snowball has been working best for me because like you said, sometimes you really need the motivation to keep going! I will have my first credit card paid off in two months! Then I really only have $1800 more consumer debt to go…the student loans are another thing completely lol.
it really all depends on how you approach it – because i know for some people the debt snowball is the ONLY way for them to become debt free, thus making it the smartest for them. 🙂 i’m so glad you’re keeping up with it, katie!!
This is awesome, Molly! I just attended a financial debt management workshop with a rep. from Ameriprise.
He mentioned the ‘pay off the higher interest rate debt first’ approach like another commenter posted above, but practically, he said the snowball method works best for most people, and that is the approach I’ve been taking, too.
thank you so much, vanessa!! and yes, that’s definitely another way to approach it, this is just the way that works best for most people 🙂
I think your advice can be helpful to those that need the mental willpower. Howvere…I would suggest something different. If each of your debts has a different interest rate, then clearly the fastest way to become debt free (assuming you don’t “give up” halfway through) would be to pay the debt with the highest interest rate off first. If you feel overwhelmed with many different obligations, then consoldation is another option. If you carry a balance one three credit cards for example ($500 on each one). Then sometimes you can instantly “pay off” the other balances and on two of the cards and have it moved over to the other card and many times the credit card compant you are moving it to will provide some incentive as well like 0% for 6 months or 12 months but there may be a flat fee of a couple percent to move the balance in the first place which is negligible. This way you can feel a sense of relief by having two less debts to worry about and you can work to pay off as much as you can to one company (not worrying about the minimum payments to the others)…or worse yet, forgetting to make any payment.
As a general rule, pay off your credit cards first as they generally have higher interest rates and do not open up charge cards from any store that offers you 5% off to open a new account. These have the ability to hurt your credit score which will hurt you when trying to get new debt down the road.
As for consolidating student loans with car loans – it is really best evaluated on an individual basis. Many times there are fees involved which make this option less beneficial and it only makes sense if the rate you will be paying after consolidation is lower than the weighted average interest rate you were paying before (multiply the interest rate by the amount outstanding for each of your debts and then add them up).
Example:
$20,000 student loan @ 5.00% –> 20,000*0.05 = 1,000
$10,000 student loan @ 4.25% –> 10,000*0.0425 = 425
$8,000 auto loan @ 8.5% –> 8,000*0.085 = 680
Add each up and divide by total debt –> (1,000 + 425 + 680)/38,000 = about 0.05539. This means overall you are paying 5.539 % on all of the debt. If you can get a consolidated loan for less than this, it may be a good idea to consolidate (take one time fees into account as well)
I studied finance in college, worked for the largest student loan provider upon graduating (Sallie Mae) and now work for a credit card company (Capital One).
there’s definitely a few different ways to approach it – this was just the best way for me and for the people i’ve worked with! 🙂 thanks, jeff!
I am currently working on a debt snowball right now. It’s a great motivator to see the little debts going away. It also just makes monthly bill paying easier when you have less payments to make.
Tara
Penniless Socialite
Win a Target Gift Card!
that’s awesome, tara!! keep it up!!
I just got a credit card but solely use it for gas for my car and small purchases to just gain some credit. I have a debit card for purchases, so that helps in terms of not racking up credit. I pay the full amount on 4 of my student loans and then have lowered the other 2 based on my low income. Honestly, there is NO way I could even have credit card debt because right now my entire paycheck goes toward rent, loans, my car, and medical expenses. Sigh. Being an adult is tough, but you have a great outlook and tips on it!
that’s great, rachel! that’s the BEST way to build your credit – and yes – being an adult is often no fun!
Hey Molly! I enjoy your series. With the advise from a fellow blogger, I just picked up the Total Money Makeover from Dave Ramsey and I am tearing into it. Good luck with all of this…and YAY for baby!!!
thank you so much!! and glad you picked up that book! it’s a GREAT one!
This really is great advice Molly and I love your finance series. It is very helpful!
thank you so much, rachel!
I am glad to hear this. I started with my smallest balance and am working my way up! Glad for the confirmation!!!!
yay! that’s awesome, danavee!!
I love your finance series, Molly! It can be awkward to talk with friends about finances–especially if they’re not in the same place as I am (re: complaining about student loans while living home. Trust me, it gets even harder to pay loans when you also have rent and utilities and city expenses!), and my Mom and Dad get slightly high-strung about it. As for today’s post, I’m proud to say I’m in zero credit card debt. My parents have always made me really aware of paying it off completely each month (I use a debit card for the most part anyways) and I rarely open store checking accounts (except for my beloved Gap card). So right now, my one priority is putting as much as I can towards my college loans each month, while still being able to pay my other bills and have a bit of fun!
thank you so much, alyssa! and that’s AWESOME that you have no credit card debt – that’s a HUGE step!
great advice, Molly! I totally agree, it’s best to start with the smallest first.
thank you so much, beth!
This is really great advice, Molly. I got myself into some credit card debt right out of college, and I couldn’t agree more with the whole mental aspect of at least getting one debt crossed off the list. It makes everything else feel much more manageable!
thank you so much, lauren!! and you’re so right – you feel SO accomplished and motivated even after paying off ONE card!
Love these posts! We are pretty stoked, paid off all our credit cards! Now on to student loans 🙂
Have a great day my dear!
Carly
http://www.lipglossandcrayons.com
that’s AWESOME, carly!! congratulations!