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. Who do you pay first when you owe everyone?
Some think you should start with the smallest debts while others argue it’s the one with the highest interest rate. Where do basic expenses fall into this equation? The answer to the debt payoff question isn’t always straightforward. There are a lot of important factors to consider, and everyone’s situation is a bit different.
Of course, if you risk having your car repossessed or facing court for unpaid bills, you should seek professional help right away. If your situation is less dire, here are things to consider when deciding who to pay first. The most important thing to do is to simply take that first step. From there, everything else is easier.
Your Necessities Come First
Before you begin paying any debts, you need to cover your basic necessities. This is anything you need to stay safe, secure, and healthy. You should always prioritise paying for your:
- Housing (Mortgage or rent)
These things above are a must not only to live comfortably, but also for survival. However, you might be able to get some things for free or low-cost depending on your situation.
For example, a local food bank could help you secure enough food for your family for the upcoming month. In addition, your landlord might take a partial payment to help you through a rough spot. Look for ways to lower how much you owe on these basics first. There are a number of local and government programs designed to ease this burden.
If you’re unable to pay for any of the above, contact your provider (ie. your landlord, mortgage lender, utility company) and explain the situation. They might allow you to pay at a later date or suspend payments if you’re experiencing a temporary crisis. Don’t be afraid to ask for help if you truly need it.
Pay the Highest Interest Debt First
Once you’ve taken care of your necessities, it’s time to look at your additional debts. Rank all of your debts in order of the highest interest rate to the lowest. This should include things like your mortgage, auto loan, personal loan, credit cards, etc.
The debt with the highest interest rate is the one that you will pay first, throwing in as much cash as you can spare. On all of your other accounts, maintain the minimum payments. 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. This is called the debt avalanche method.
Let’s look at a simple example. Say you owe $3,000 on a credit card with ABC Bank. It has an interest rate of 18%, a minimum monthly repayment 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 1 year and 6 months as opposed to 7 years and 10 months with the minimum repayment.
Using the Debt Snowball Approach
There’s no perfect formula when it comes to paying off your debts effectively. What works for one person might be a poor fit for someone else.
If paying your high-interest debt first sounds intimidating, try the debt snowball approach instead. This is when you list all your debts in order of lowest balance to highest balance. Then, you attack the smallest amounts first.
Once the first debt is gone, throw all your spare cash at the second smallest one and so on. 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.
Create a Long-Term Repayment Plan
The most important thing to remember when thinking about who to pay first is that you need a repayment plan. When you’re simply paying the minimum each month, you’re not putting much thought into aggressively paying down your debts.
Since a repayment plan can feel complicated, let’s keep it simple. Here’s a basic plan that fits most situations:
- Create a budget: To start, create a budget. Write down your monthly expenses and income, including all of your minimum debt payments.
- Build your emergency fund: Everyone needs an emergency fund. This is money set aside just in case. It should be at least $1,000. To building this, put any extra funds after paying your expenses and minimum debt payments towards creating this safe cushion.
- Choose a payoff method: Once you’ve built your emergency fund, turn that extra payment to either your highest interest account or your lowest balance account.
- Watch your progress: Keep track of your progress each month with a budgeting tool and debt tracker.
When you’re struggling with debt, it’s easy to feel like this situation will last forever. In reality, debt is temporary. By taking steps, no matter how small, you slowly but surely build a stronger financial future for yourself and your family.
Take That First Step to Debt-Free Living
While there are so many different ways to approach the question of who to pay first, it’s important to find what works best for you. While paying the higher interest first might save you money, it could be more challenging to stay motivated. On the other hand, the debt snowball method might not feel aggressive enough depending on how much you owe.
As long as you’re making payments and creating a plan, you’re going in the right direction. In the meantime, we’re here to help. You don’t have to take these important first steps alone.
If you are looking for professional debt management solutions, Debt Busters are here for you. Taking your unique circumstances into account, we can put together a unique plan that works for you. Call us on 1300 368 322 now, fill in the contact form or connect with us on webchat to get your finances back on track today.