How Do I Decide Which Debt To Pay Off First? 5 Options

I recently received an email from a reader. Here’s a snippet from the email (republished with his permission):

NCN, I enjoy your blog. I have several different types of debt. I owe my dad some money, I have three credit cards with balances, and I have two automobile loans. On top of all of that, I have a mortgage. Which one of these should I pay off first?

Before I give my opinion, let me remind you that I am NOT a financial adviser nor am I financial professional. I’m just a guy who writes a blog about my life and my finances. So, the following is NOT professional advice.

First, remember to make all minimum payments to all accounts. Do not try to pay off one account (by paying extra) to the neglect of meeting the minimum payment of another account. I know very, very little about delinquent accounts or accounts in bankruptcy, so the following pertains to individuals who are making minimum payments and are ready to rapidly repay their debts. Include or exclude your FIRST mortgage from any of the following, depending on your current situation.

Option 1: Family Matters (Personal Loans First)

If I faced a situation where I owed money to a family member or friend, I’d probably push this type of loan to the “front of the line”. Why? Well, it would be strange to hang out with someone to whom I owed money. It would just be “weird”. After reading this post over at The Simple Dollar, I’m convinced that loaning money to (or borrowing money from) a friend is a bad idea. But, if you are cool with owing your parents or friends money, skip Option 1 and head to Option 2!

Option 2: Calculators Rule (Highest Interest Rates First)

Very simply, pay your debts off, starting with the account with the highest interest rate. (In his world famous Dave Ramsey Is Bad At Math post, Nickel points out the simplicity of this mathematically efficient method.) Basically, line up your debts, regardless of type or amount, and pay them off according to their interest rates.

Option 3: Feelings, Nothing More Than Feelings (Highest Balance First)

Ah, the good old Dave Ramsey-inspired Snow Ball method. Used by yours truly, this method works on the principle that we are motivated by watching ourselves make progress. So, instead of focusing on interest rates, you focus on account balances. Line up the balances, smallest to largest, and pay off the account with the smallest balance first. By focusing on the smallest balance, you can ‘see’ your progress and you will be inspired, getting rid of one debt after the another. I liked this method, especially when I first started out, because every time I paid off an entire account, I was motivated to keep going, and going, and going. Does this method work? Read this post about me and my journey.

Option 4: Plastic Pollution (Credit Cards First)

Let’s face it. There’s debt and then there’s DEBT. (Personally, I don’t categorize debt as ‘good’ or ‘bad’, but I am able to realize that some types of debt can be ‘better’ or ‘worse’. I don’t plan on borrowing money, but I have no real problem with having a mortgage, taking out a student loan or even borrowing money to buy a car. But, credit card debt, really, really concerns me.) So, if you are cool with having a note on your car or having a second mortgage, you might consider focusing on your credit card debts first. (Side note: NCN, would you use a second mortgage to consolidate your credit card debt? Probably not. I’d simply pay my credit cards off and change my habits. Most people who consolidate their loans never change their habits, and they end up with a second mortgage and MORE credit card debt.) Simply use Option 1 or Option 2 and focus on your credit card debt. (Throughout the debt reduction process, I’d also look to move credit card balances from higher rate cards to lower rate cards. But, be aware that focusing too much on a sweet ‘balance transfer deal’ might derail your debt reduction progress, if you stop making extra payments. For more on this topic, checkout this article over at Blueprint For Financial Prosperity.)

Option 5: The More The Merrier (All Accounts Equally)

Here’s an interesting idea, given to me by a friend of mine. While getting out of debt, he never focused on any particular debt category or debt type. He simply paid his minimums, and added 5% extra to ALL of his accounts. Over time, he got out of debt much faster than he would have if he had only paid his minimums. Adapting his technique, you might choose to pay more towards several different debt accounts. If you have 3 credit cards, all with $50 minimums, you might want to send all three companies an extra $10, instead of $30 to just one company. Why? This technique might help build goodwill between you and your creditors. Think of Option 2 and 3 as rifles, directing your bullet at one, specific target. Think of Option 5 as a shotgun, directing several pellets at several targets.

Bonus Option: WWND? (What Would NCN Do?) Instead of tacking this Bonus Option onto the bottom of this post, I’ll write a full post about exactly what I’d do, today, if I found myself in debt. Stay tuned!