Having multiple credit accounts make it harder to pay off debt. You will feel a lot of stress because you have so many payments to keep track of. It actually gets worse if you know that your income is not enough to cover your debt payments while sustaining the type of lifestyle that you want to live.
The fact that you will be forced to lower or change your lifestyle can add to the stress and frustrations that you feel as you try to get out of debt. When you are feeling stressed, it will affect your ability to make smart decisions. Not only that, but it will also affect your happiness, relationships, focus, etc.
Unfortunately, a lot of people are struggling and suffering under a huge amount of stress because of their debt payments. Reports reveal that 78% of Americans admit that their financial situation is causing them a lot of stress in their life. They even revealed that they spend approximately 41 minutes worrying about their finances.
If you do not want that kind of life, it is important for you to figure out how you will pay off debt. It is not advisable that you let it go for long without resolving it. You need to find the right way for you to pay off your debts. It is not enough that you consider where you will save the most. You should also look beyond your financial capabilities. It is also important to gauge your personality in terms of what will make you complete the debt solution that you will choose to get out of debt.
When you consider all of these, you can easily determine the right order by which you will pay off debt.
2 different strategies to pay off debt
Why is it important to determine the order that you will pay your debts? If you have multiple debts, it makes sense to rank them according to priority. Before we discuss the options to rank debts, let us identify the debt solution that follows after.
The idea is to focus your limited finances on the top-ranking debt while maintaining the minimum payment requirement on the rest. By focus, that means all the extra money that you have will be paid towards the top-ranking debt – or the priority. With the extra payments, you will be more likely to pay off the priority debt a lot faster. Once paid off, you can use the freed money to pay off the next priority debt while the rest continues to receive the minimum required amount. This will go on until all the debts are paid off.
So how can you do this? There are two ways to determine the ranking of your debts.
Pay off the one with the highest interest
The first if to rank your debts according to the interest. That means you will prioritize the one with the highest interest rate. This is ideal for those who want to save a lot of money. If you do not get rid of your high-interest debts, it will grow quickly because of the way it compounds. According to reports, Americans are expected to spend $122 billion on the interest amount of credit cards alone. This is just in 2019. By eliminating the high-interest rates first, you will be lowering the finance charges that will be added to your debts. It will not have the chance to compound – or at least, a lower amount will be compounded.
For those who are logical in nature, this is the right order to pay off debt. They would want to pay off the one with the highest-interest because it gives them the most chance to save money. If your future plans include the need to have more savings, this is the best way for you to pay it all off.
However, this comes with some drawbacks. If the debt with the highest interest rate has the biggest balance, it will take you forever to finish this priority debt. It will drag out the feeling of success that comes with succeeding in paying off a debt completely. If you do not have the right personality for this arrangement, you might end up feeling frustrated and discouraged about the whole thing. It can feel like the debt solution is not working. This is why some people opt for the other strategy to pay off debt.
Pay off the ones with the smallest balance
The second way to rank your debts is through the balance. This time the priority debt will be the one with the smallest balance. It does not matter how high or low the interest rate is. If it has the least amount, it will be made the priority.
This method is ideal for people who are more emotional about their debts. Sometimes, people start a difficult task only to falter because the end is too far in the future to motivate them. This is what can happen if you have a lot of debts with a high balance. Your inability to aggressively lower your balance or completely pay off the debt in a short amount of time can make you feel like you are just wasting your time.
This is why prioritizing the smallest balance makes sense to some people. It will allow them to experience the rushing feeling of success that comes with making that last debt payment on a credit account. It will give them the motivation they need to complete the other debts that they owe.
While it is encouraging, this option is not ideal for people who want to save money on their debts. If the smallest balance has a low-interest and the one with the high-interest is low in the list of ranking, that can make you pay more in terms of interest.
What to consider when choosing how to pay off debt
Now that you know your two options to rank the order to pay off debt, you need to find out which is the right option for you. Here are some tips on what you should consider when making a choice.
Start by looking at your payment capabilities. You may be surprised that some people are not confident with what they can afford in terms of debt payments. In fact, one study revealed that almost half of student loan borrowers are uncertain about their ability to pay off their debts. Obviously, if this is how you feel, you need to do something about your financial situation. There is no question about it – you need to pay off your debts. You just have to find the right debt solution that will help achieve your goal despite your limited financial resources. So if saving money is important, you know that you should prioritize the high-interest debts.
This might seem like a weird consideration but it makes sense if you understand how your personality plays a role in your ability to complete a project. As mentioned, some people are more logical or more emotional than others. Your choice should lean towards what will motivate you to complete the debt solution. If having a lot of savings will motivate you to pay off debt, then prioritize the high-interest debts. But if you know that you need positive reinforcement to keep yourself motivated, then go for the smallest balance first.
Finally, your choice should consider your future financial goals. Some people are too focused on getting out of debt that they fail to realize that there is life after debt freedom. What will you do after? Will you allow yourself to start from zero? Why not just start working on your financial goals while you pay off debt? This is possible as long as you use the right debt solution. For instance, if you want to buy a house after debt freedom, you need to save enough money for the downpayment. Your debt solution should help you accomplish that.