Which Debt Should You Pay First?
Many people believe that credit card debt is the worst kind of debt. Credit card debt can be a big problem, and this is especially true if you live in one of the 10 cities with the most credit card debt. However, it isn’t always the worst kind of debt, and sometimes, you will have a good reason to pay a different debt off first. You need to take several things into consideration when determining which debt you should pay off first.
What is the worst of your debts is only one part of the equation. You also need to determine which of your debts might be helping build your credit score (or hurting your score), and how the different debts affect your goals, as well as your finances (including your taxes). Here are four key things to consider before you rush to pay off your credit card.
Determine which debt is the worst
Credit card debt can be dangerous because of the potentially high interest rates. According to National Debt Relief, the five major kinds of debt include student loan debt, credit card debt, mortgage debt, tax debt, and auto loan debt. If you pay only the minimum balance on your credit card, you may be paying it back for a long time. If you take out a large student loan and you can’t find a job, you might be in trouble. On the other hand, you need to consider which of your debts are secured or unsecured; you might have higher interest on your credit card, but you don’t want to lose your house by neglecting your mortgage debt.
National Debt Relief writes that the worst debt is the debt you can’t pay on time. This is because your credit score can be negatively affected, your balance can grow if you can’t make the payments, and you might need to borrow more money in order to make your payments. This makes perfect sense, and is important to consider when you are deciding which debt is the worst, and which debt you should pay off first. If you can’t pay for your auto bill, that might be your worst debt because without a car you may not be able to commute to work, and then you may lose your job and go into even bigger debt.
Consider your credit score
If you regularly fail to pay your bills on time or you max out your credit cards, you will end up harming your credit score. Your credit score is important for several reasons. Having strong credit will help you to qualify for loans; lenders use your credit report to determine if and how much credit you should qualify for. When determining which debt to pay, you will want to consider your credit score; this is particularly true if you are hoping to secure a loan for a house or other big item soon. If you are hoping to take out a loan, you will want to focus on improving your credit score.
Simply paying off a debt won’t necessarily change your credit score overnight. If you have made many poor financial decisions, or you have regularly missed payments, you will need to repair your credit. To do that, according to myFICO you should first check your credit report. Next, set up payment reminders, and reduce the amount that you owe (begin by stopping credit card use, and then come up with a payment plan that prioritizes paying off debt with the highest interest, but still leaving funds to pay the minimum on other bills). Also be aware that if you continue to pay debts on time, and you have for a while, doing so can positively affect your credit score too.
Think about your goals
Most likely, being gravely in debt isn’t one of your financial goals. While you may have extensive student loan debt, you may not want to pay that loan off first if the interest rate is low. It is a good idea to regularly meet the minimum payments, but you might want to prioritize a different debt. This depends on your goals. If you want to be debt-free by 2020, then you just need to start paying debt now, and you should pay debt with the highest interest off first in order to avoid accruing more debt.
However, if your goal is to stop paying a monthly auto bill, then you might want to pay the minimum on your other debts, and put extra money toward your auto bill. You should certainly consider what the smartest financial move is, but you also want to think about your personal goals. You also might enjoy paying off a few smaller debts; doing so might help give you the encouragement that will motivate you to work toward paying off bigger debts.
Remember your finances
In the end, you can only pay as much as you can afford. Simply wanting to pay off debt isn’t enough. In order to come up with a repayment plan, you will need to look at your debt honestly, and determine just how much you can pay each month. If you are truly in serious debt, and you are dealing with debt collectors, you may want to consider ways you can reduce your debt, such as loan consolidation, or putting student loans on hold for a legitimate reason. You also can consider taking on a second job if possible, or cutting expenses where possible in order to reduce debt.
It’s also important to think about your taxes. There are several different student loan tax credits you may be able to claim. If you have tax debt, you should also think about that when deciding which debt to pay first. An estimated 17% of federal taxes go unpaid each year; if you don’t resolve these issues, you may have property seized, or you might even face jail time.
There is usually no easy answer when determining which debt to pay. It’s important to think about how much money you can afford to pay, which debts have the highest interest, which debts affect your credit score, and how paying certain debts will help or hinder your ability to meet your goals.