What is the Correct Order of Paying off Debts?

Getting out of many debts is one smart move if you want to be financially free. It is a worthwhile goal that anyone wants to achieve. Who would not want to be debt-free?

It is easy if you only have one creditor, but it can be difficult, when you have several creditors.

It can get overwhelming to know that you have several debts to pay. Fortunately, there are two methods that experts usually recommend – the Avalanche Method and the Snowball Method. They determine the order of paying off debts. Read below to learn more and identify which strategy best work for you.

Why knowing the order of paying off debts is important

It would help if you understood that debt plays a significant role in your financial health. This affects your monthly budget, savings, and credit score. You already know that having a tremendous amount of debt can affect your credit score, which affects your qualifications to get approved for a loan.

You should pay your debts on time. When you miss a payment, your assets may be seized by the lending company in cases of secured loan, or the lender will report to the credit bureaus about your delinquency in payment. To maintain a good credit score, you should keep your balances as low as possible.

Different ways to pay off debt

If you’re determined and ready to pay off your debts, make sure that you have a payoff plan for your debt. If you have only one loan, then it’s easier to pay it off. But, when you have several, it can get challenging.

There are different strategies to pay off debt, with various benefits and disadvantages. One approach might work for one person but might not work for others. However, no matter what strategy you will use, as long as you are focused on paying off your debt, you will achieve it. Read below and know what the order of paying off debts is for you.

Avalanche Method

In this order of paying off debts, you will pay off the debt with the highest interest first. This method is also known as “debt stacking.” First, you make minimum payments to all your debts. Second, you put the extra money into the debt with the highest interest rate. And lastly, if the debt with the highest interest rate has been paid off, pay off the debt with the next highest interest rate, and so on.

It is called an avalanche method because once you get the momentum in paying off your debts, the remaining debts will fall away quickly. Every time you pay off a debt with the highest interest rate, it would be easier for you to pay for the remaining debts. You will spend less because the ones remaining are those with low-interest rates, which makes it quicker for you to pay off your debt.

The downside of this method is that it will generally take longer to see progress. For example, if the debt with the highest interest rate is your largest debt, then it may drag on for how many months or years before you can pay it off. You might feel like you are not making any progress, which can result in losing focus in paying off your debts.

Snowball Method

This method is making extra payments to debts with the lowest balance first. In this order of paying off debts, only when the debt with the smallest balance is paid off that you start on making extra payments for the debt with the next lowest balance.

First, you make minimum payments to all your debts. Second, you put the extra money into the debt with the lowest balance. And lastly, once the debt with the lowest balance is paid off, take the extra money you were using to pay it off the debt with the next smallest balance from the first one.

It is called a “snowball” because as you pay off one debt, the money that you will use to pay for your debts will get bigger to pay off the next smallest debt much quicker, just like when a snowball gets bigger, it will pick up more snow.

Some people love this method because whenever they pay off one debt, they feel like they have achieved a small success, which keeps them motivated and focused on paying off their debts. There is also the potential of increasing the credit score because debts are paid off quickly.

The downside of this method is that you will end up paying more. Since you will not take the interest rate into account with this method, there is the risk of paying debts with high-interest rates later.

Takeaway

Paying off debts can get stressful, especially if you don’t know which debt to pay off first. Good thing there are methods recommended for you to use in paying off debts. No matter what method you choose, the important thing is that you will pay off your debt. The sooner you figure out what method is for you, the faster your debts will be paid off.