Prioritizing Debt Repayment

financial mastery

A strategic approach to debt repayment can accelerate your financial pursuits while the opposite, a random approach, could slow you down or even set you back.  Here are some ways to strategize debt repayment.  

Starting with The Debt with the Highest Interest Rate - This is known as the debt avalanche. It focuses on ordering debts from the highest interest rate to the lowest. Debt with a high-interest rate can be difficult to pay off if most of the payment is dedicated to interest charges and little of the payment reduces the outstanding balance. Eliminating this high-interest debt first will reduce interest charges and allow other debts to be addressed sooner, as well. Imagine an avalanche with debt tumbling down quickly.

Starting with The Debt with the Least Balance - This strategy is good for gathering momentum and building a debt-elimination mindset. It is known as the snowball debt repayment strategy, and it can provide as much motivation as debt reduction does. If you are unable to determine which debt to pay off first, begin with the debt with the lowest balance. Once this first debt is eliminated more cash will be available to pay larger debts. This strategy is useful if the avalanche strategy is not immediately appropriate.

Starting with the Largest Balance - This is the opposite of the snowball strategy. Beginning with the largest outstanding balance is sometimes unpopular because retiring the debt can require significant time and discipline. Focusing on this debt may not provide flexibility to achieve other financial goals because the corresponding payments may also be large, which could be limiting. Also, if this debt has an interest-free period or a low promotional rate it may be best to reduce the balance first or prior to the introduction of a higher interest rate when the promotion ends.

Consolidating Your Debts - This is usually an option taken when someone has been unsuccessful in utilizing other repayment strategies. In this strategy, many debts are repaid with a single loan. Several payments are now consolidated or reduced to a single payment associated with the new, single loan. Depending on the types of debt being consolidated and the rate and term of the new loan, total interest charges and payments could be lower. Consulting with an independent financial advisor is recommended because the opposite could be true, which will make a difficult situation worse.