Have you ever wondered which debt to pay off first?
If you’re anything like me, there’s a possibility you have 5 or more loans. (Between my husband and I, we have 17 loans. Crazy. I know. It’s why I absolutely hate debt.) Having so many loans can be very overwhelming and, when it comes to paying them off, it’s often hard to know where to start.
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You probably know how important it is to pay more than the minimum required payments if you want to pay off your loans as quickly as possible. But which debt should you put that extra money towards each month? Should you put it towards the largest loan amount or maybe divide it equally between all your loans?
Actually, there are two good options for which debt to pay off first. I’ll tell you what they are further down, but first you’ll need to gather a little information about your loans.
Gather the Essential Information
In order to decide which debt to pay off first, you’ll need to know at least a little about each of your loans.
If you’ve never looked at this information before, you should be able to find it on whatever website you use to make payments towards your loans. There should be a page titled “Loan Details” that houses all of this information.
I highly recommend looking at this information at least once every three months in case anything has changed (sometimes interest rates and minimum payments change), even if you already have a loan repayment strategy set up.
Here are the three things to find for each loan:
1. Remaining Loan Balance
What is the remaining balance on the loan? This is the amount that you still owe towards the loan. If you’ve only been paying the minimum balance towards the loan, the remaining balance may be higher than the original balance because of interest. I made the mistake of only paying the minimum for a few years following undergrad and some of my loans still have a higher remaining balance than the original balance, even though I’ve been seriously working to pay them off for about two years. Don’t let this happen to you.
2. Interest Rate
A loan’s interest rate is important because, if you don’t pay attention to it, you can end up paying much more than necessary over time. This obviously isn’t the case if the interest rate is 0% (lucky duck), but even a rate as low as 3% can really add up. This is why you don’t want to drag out paying your loans just because you can. In the long run, you’ll end up paying thousands more than you would otherwise… and I mean thousands. My husband and I have a plan to pay off our loans (totaling over $100,000) over the next 5 years and we’ve calculated that we’ll end up paying around $8,000 in interest. Now imagine how much interest we’d pay if we decided to only pay the minimum required payments over the next 20+ years. Yeah, no thanks.
3. Minimum Payment
You should already know what your minimum payments are, since you’re likely paying it or something close to it. Mostly this information is helpful in knowing how much interest you’ll pay over time. You won’t necessarily need it to determine which loan to pay off first, but it is necessary if you want to use a repayment calculation tool to look at your loans more in-depth and create a detailed loan repayment strategy.
Choose the Option that Works Best for You
Now that you know the loan balance, interest rate, and minimum payment for each loan, you’re ready to decide which debt to pay off first. There are two good options:
Option 1: Pay Off the Debt with the Lowest Remaining Balance
Option 1 works by taking an extra sum of money, on top of your minimum payments, and putting it towards the one debt with the lowest remaining balance.
Say you have an extra $20 dollars that you can put towards debt each month. Focus on putting that towards the loan with the lowest balance.
Paying off the debt with the lowest balance allows you to pay off loans at a fairly even pace. You’ll pay off your first loan relatively quickly and then other loans will follow in being paid off every few months or so. (This obviously depends on the size of each loan and how much you’re putting towards debt. If you’re putting $200 a month towards a $1,000 loan, it’s going to be paid off much quicker than $50 a month towards a $5,000 loan.)
The option of paying off the loan with the lowest remaining balance is great because you get quick wins. You’re regularly paying off loans and that success fuels you to pay off more loans faster. If you need that extra motivation of seeing quick results (and I think most people do), then this is a great option for you.
Option 2: Pay Off the Debt with the Highest Interest
The second option is to take that same sum of money and, instead, put it towards the loan with the highest interest rate first. If you have two loans with the same interest rate, you would put it towards the one with the highest remaining balance.
This is the method I use to pay off my loans. Here’s why: This method will allow you to pay the smallest amount of interest possible.
If you need quick wins to keep you motivated, I would suggest using the first option. But if you have a large amount of debt and think you can stay motivated without paying off loans regularly, you might want to consider this route.
For my husband and I, using this method will end up saving us at least $1,000 in interest.
If you do choose to go with this method, it’s important to find a motivating factor to keep you going when there’s a longer stretch between loans being paid off. With our debt plan, there will be a year-long period when we don’t pay off a single loan. To stay motivated, I like to look at the current total remaining balance of all our loans combined and compare it to what it was six months ago. Maybe we haven’t paid off a loan recently, but paying off $8,500 in six months still feels like a win.
Don’t Forget to Snowball
One last note about these paying options: both of them work best when you snowball your payments.
I learned the debt snowball method from Dave Ramsey and it has, and will continue to, play a huge part in being able to pay off our loans as quickly as possible.
Essentially, snowballing is picking one set amount that you will pay towards your debt each month and then continuing to pay that same amount until all of your loans are paid off. When you pay off one loan, you simply add that loan’s minimum payment to the extra amount you were paying and pay it towards the next loan in your plan (either the loan with the smallest balance or the loan with the highest interest, depending on which option you chose above).
For example, my husband and I currently pay $1,700 each month towards our loans. Unless we decide to raise that amount at some point, we will continue to pay $1,700 even as we pay off specific loans.
One Last Note
Now you know how to decide which debt to pay off first!
Having a plan will help you keep on track and enable you to pay your loans off as quickly as possible.
If you haven’t already, take a few minutes to gather the information mentioned above and decide which loan repayment option will work best for you. Then make paying off your loans one of your long-term goals.
Which option did you choose? Send me an email and let me know!