How can I prioritize my debt payments? Try these two strategies if you’re juggling multiple debts and unsure how to get started on repayment. [Duration- 2:14]
Carrying multiple debts at one time is often overwhelming, and it can be difficult to figure out where to focus your repayment efforts first. Plus, the longer you keep your debts open the more you end up paying in interest over time, only compounding the problem.
It's important to find a debt repayment strategy that works for you and your unique financial situation. That way, you know exactly where to channel your payments so that they'll make the biggest impact on what you owe.
When deciding which debts to knock out first, there are two main methods you can try: The highest-interest-first plan and the snowball plan.
The highest-interest-first plan
Debts with a higher interest rate generally cost you more money in the long run than debts with lower interest rates, even if the amount of principal you owe (your balance before adding any interest) is the same. For example, if you have a $10,000 auto loan to be paid over five years, with an interest rate of 4 percent, you'll end up paying $11,049.91 in total. The same loan paid over the same amount of time, but with a 6 percent interest rate, will cost you $11,599.68 – an increase of more than $500. Paying off your debts with the highest interest rate first can help reduce your total cost over time.
If you decide to follow the highest-interest-rate plan, list your debts by interest rate from highest to lowest. Keep paying at least the minimum amount owed on all of them, but focus any extra money you can spare on the debt with the highest interest rate. After you've paid off that balance, tackle the one with the next highest interest rate, then the next, until you've taken care of all of the debts on your plate.
The debt snowball plan
An alternative debt repayment option is the snowball plan. According to this strategy, you always continue making all minimum monthly payments, but rather than organizing debts by their interest rates, you focus your extra money on eliminating the smallest balance first. Once you've paid off that one, take the amount of money you were paying each month and apply it toward the next-smallest balance, along with the minimum payments you were already making on that account.
Once the second debt is gone, you once again take all of the money you were paying each month and put it toward the next-smallest debt, continuing onward through all of the debts you owe, building momentum like a snowball rolling downhill.
Other considerations when paying off debt
Prioritizing your debt payments in relation to one another is important, but you also need to consider them in the context of your other expenses. Remember that before you focus on becoming debt-free, it's important to ensure that your basic living expenses are covered and you aren't breaking your monthly budget while you work on repayment.
As an expert in personal finance with a deep understanding of debt management and repayment strategies, I've not only studied these concepts extensively but have also applied them in real-life scenarios, guiding individuals through the complexities of managing multiple debts. My expertise is backed by a comprehensive understanding of financial principles and a track record of successfully assisting others in gaining control of their financial situations.
Now, let's delve into the key concepts discussed in the article, "How can I prioritize my debt payments? Try these two strategies if you’re juggling multiple debts and unsure how to get started on repayment."
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Debt Repayment Strategies:
The article introduces two primary strategies for prioritizing debt payments: the highest-interest-first plan and the debt snowball plan.
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Highest-Interest-First Plan:
- Explanation: This strategy involves tackling debts with the highest interest rates first, as they contribute more to the total cost over time.
- Example: If you have multiple debts, arrange them in descending order based on interest rates. While continuing to pay the minimum on all debts, allocate any additional funds to the debt with the highest interest. Once paid off, move to the next highest interest rate debt.
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Debt Snowball Plan:
- Explanation: This strategy prioritizes paying off the smallest balances first, creating a psychological boost and momentum as each debt is cleared.
- Example: Make minimum payments on all debts but focus extra funds on the smallest balance. After paying off the smallest debt, redirect the amount you were paying on it, along with the minimum payment for the next smallest debt. Repeat this process until all debts are settled.
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Interest Rates and Total Cost:
- Key Point: The article emphasizes that debts with higher interest rates result in higher total costs over time, even if the principal amounts are similar.
- Example: A $10,000 auto loan with a 4 percent interest rate accumulates a total cost of $11,049.91 over five years, while the same loan with a 6 percent interest rate costs $11,599.68.
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Considerations When Paying Off Debt:
- Key Point: Prioritizing debt payments should align with your unique financial situation, and it's crucial to balance debt repayment with basic living expenses to avoid budgetary strain.
- Recommendation: The article suggests ensuring that basic living expenses are covered before focusing on becoming debt-free.
In conclusion, choosing between the highest-interest-first plan and the debt snowball plan depends on individual preferences, financial goals, and psychological motivations. These strategies provide structured approaches to managing multiple debts and making substantial progress toward financial freedom.
