Deciding which of your debts to pay off first can be brain tasking, especially when you are already feeling the burden of each debt and want them to disappear as soon as possible. Don’t worry; you are not alone.
According to the Federal Reserve, US households now have a record $14 trillion in student loans, credit cards, mortgages, car loans, and other forms of debt. Mortgages alone has a record of $9.44 trillion.
Before deciding which of your debts to pay off first, you need to know the four main debt areas: student loans, car loans, mortgages, and credit cards. Almost every American has a debt to pay in one of these areas, even more.
To know which one to attend to, you’ll need to look at each on a deeper level. For example, what are the benefits of paying each of them? Are there also disadvantages of not paying them as soon as possible? These questions will help you prioritize which to debt to clear first.
Carefully read this article if you want to know the pros and cons of clearing each debt and how to prioritize which debt to pay off first.
What debts should I pay off first?
Here are the four areas to consider when you decide it’s time to pay off your debt:
1. Mortgage Debt
When you look at the interest rate on mortgages, which is like 4%, you might be tempted to put off paying it. The interest rate is not high compared to the interest rate of other types of debt.
For instance, the interest rate on credit cards is between 15-30%. So, you might even consider paying the credit card debt before considering the mortgage debt. However, you might want to think about it a bit carefully.
While the interest on a credit card may be more, the principal owing on a mortgage is higher than that of the credit card. This runs into hundreds of thousands of dollars. And seeing mortgage payments take a longer time to pay, you may want to start sorting it out as soon as possible.
So why should you pay up your mortgage debts before any other debt?
The answer is to save money. If you can pay your mortgage debt early, you can save hundreds or thousands of dollars. The loan interest will lessen, and you can fulfill your dream of becoming a homeowner.
However, if you don’t pay the debt quickly, the interest will keep rising.
How do you pay off your mortgage debt early?
There are many methods, but the easiest is adding an extra payment to the normal monthly one. For example, if you send 12 checks for each month, increase it to 13. Another way is increasing the amount you pay monthly.
But another thing to consider is the amount of money you can earn if you invested the money you plan to pay towards your mortgage principal. The funds you could gain from investing, in say, an index fund, your returns will be higher than the money you saved on the loan’s interest.
However, there is also a benefit that comes with paying your mortgage principal early, building equity. If you ever decide to sell the house, you’ll make more money than you bought it. Seeing real estate is the new gold, your investment returns will be worth it.
2. Student Loan Debt
According to the U.S Federal Reserve, many Americans owe student loan, and it’s about $1 trillion. They don’t get to repay it immediately after graduation. Nearly three million still owe even after 60 (according to the consumer financial protection bureau).
Student loan will remain with you for life if you don’t pay off. It’s not something that can disappear even if you declare bankruptcy. It will help if you put plans in place to repay them.
If you are yet to take out a student loan, it’s advisable to go for the federal government-funded loans than the private. The reason is that the former comes with low-interest rates and reasonable repayment terms.
Also, be careful not to borrow more than you need; else, you’ll end up squandering it. Take out time to plan out your college education in line with keeping costs to the barest minimum. If you can do this, your debt won’t be overwhelming.
If you’ve taken the student loan, you need to start paying as soon as possible. You can start small, but ensure it’s regular. Keep money aside for it.
3. Car loan Debt
Paying off an auto loan debt depends on the payment terms. Some might come with a no-interest offer, which means you only have to pay the principal. If you have this kind of offer, there’s no need to prioritize payment.
But if there is a loan interest attached to it, say 4% or higher, and the duration is longer than 59 months, then you should make it top of the debts to pay off. Why?
A vehicle does not appreciate; instead, it depreciates. If you don’t pay off the debt fast, you’ll end up paying for a car with less value in the future.
Before getting a car, you should search for a car loan with the lowest interest rate. The terms should also not be more than five years, so the car doesn’t lose value. Paying off your car loan debt should be one of your topmost priority.
4. Credit Card Debt
Having credit card debt is a nightmare. Aside from the high-interest rates, which could be up to 30%, most things you purchase with credit cards have no value. You can’t even look back and smile at the good you’ve done!
With a student loan, you can get a job that brings in cash with your degree. A mortgage interest gives you a home. A car loan gives you a car that gets you from point a to b. What does a credit card loan give you? Nothing! No disrespect to electronic gadget lovers.
Another thing with credit card loans is that you might purchase a cheap item but pay more money for it due to the high-interest rates on credit cards. For example, if you buy a jacket worth $250, the final payment might be $300.
Credit cards are necessary evils. But changing the way you use them determines if you’ll save or end up with debts.
The first thing you want to do is ensure the credit limit is not more than $10000. The lesser, the better, because you’ll control your spending.
Also, you want to use cards that do not have high-interest rates. Take time to search for them. It would be best if you aimed at most 15% interest rate.
Only use your cars when you have no other option, as an emergency. Quit the impulsive buying already.
Finally, ensure you pay off the debt every month, if it’s the last thing you do (well, not the last thing, but try!). That way, you are not rewarded with high-interest rates. You also don’t get a carryover of debt to a new month.
Conclusion
Deciding which of your debts to pay off first is your call because you know how much you have and at what point you have it.
If you have a massive sum of extra money and wonder what to do with it, you may want to start paying off your car or student loan debt.
If you keep rolling your credit balance to the next month, it’s time to take a pause and pay off.
With the guidance of this article, you decide which one first.
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