Choosing who to pay first can be an exhausting juggling act. If you have a number of credit cards, a car loan, unpaid utility bills and debts with family or friends, it’s tough deciding which to prioritise.
Should you start with the smallest debts or the one with the highest interest rate? The answer isn’t always straightforward. Of course, if you risk having your car repossessed or facing court for unpaid bills, you should contact us urgently for expert help. If your situation is less dire, here are two different debt management approaches you can take.
Pay the highest interest debt first
Rank all of your debts in order of the highest interest rate to the lowest. The debt with the highest interest rate is the one that you will pay first, throwing in as much cash as you can spare, while maintaining the minimum payments on all the others. Once the first debt is cleared, you can use the extra funds to pay down the next one. You will notice your debts reducing sharply as time goes on.
Here is an example using an online credit card repayment calculator. It is an estimate only, and variations can occur depending on the way calculations are made and any other fees and charges.
You owe $3,000 on a credit card with ABC Bank. It has an interest rate of 18%, minimum monthly repayments of 2% (or $60) and no annual fee. You also have a credit card with XYZ bank with a balance of $5,000, an interest rate of 13.5%, a minimum monthly repayment of 2% (or $100) and an annual fee of $60.
You decide that the highest interest rate credit card is the one that you want to pay first. By increasing your monthly payments to ABC Bank to $200 per month, you will get rid of the debt in one year and six months as opposed to seven years and 10 months with the minimum repayment. More excitingly, you will save $2,162.56 in interest payments.
Once you have zeroed your balance with ABC, you can afford to pay $300 per month towards XYZ. (That is the minimum of $100 plus the $200 you were previously paying to ABC). You will then be able clear your XYZ card in one year and eight months as opposed to six years and nine months at the minimum monthly rate. Your interest savings will be a whopping $2,047.87.
This can be a good approach if you are able to be disciplined with your finances and spending.
Debt snowball approach
Another approach is to list all your debts in order of lowest balance to highest balance, and attack the smallest amounts first.
Once the first debt is gone, throw all your spare cash at the second smallest one and so on. As each debt is cleared, you will have an ever-larger sum to pay down the next debt, much like a snowball rolling down a hill.
The reasoning behind this method is purely psychological. It might not be the quickest way of paying off debt, but it can be helpful if you struggle with financial discipline. As smaller debts are relatively easy to clear, you will be proud of your success and more motivated to stay on track.
Considerations of who to pay first
The first approach is the best way to pay off your debts because it will cost you the least interest over time, however, if your debts are overwhelming you or you simply don’t know where to begin, then the second method of paying the smallest debts first will give you the financial success and confidence you need to start.
If you are looking for professional debt management solutions, we’re here to help! Taking your unique circumstances into account, we can put together a unique plan that works for you. Call us on 1300 368 322, fill in the contact form or connect with us on web chat to get your finances back on track today.