Which Debt Should You Pay Off First?

Debt

Now that you’ve made a budget and learned strategies for sticking to it, which debt should you pay off first? There’s a few ways to go about it. In today’s post we’re going to give you four strategies you can approach your debt.

It’s always good to have a plan. As we talked about in budgeting part 1, setting goals before you start a budget is key so you know where you’re going. 

If paying off your debt is one of your goals then you’ll also want to dig a little deeper into which debt to pay off first. Once you have more free cash flow, you need to know where that money will go next.

What’s the One Trick to Paying Debt Off Faster?

Truth be told, there are no shortcuts. There is no one right answer here. Coming up with a solid plan and sticking to it is a huge win for you and your money. 

One thing I can tell you is that paying minimums is NOT the way to go.

The right answer is what works best for you. You’ll notice some options below are more mathematically sound. This means they are optimal from a purely financial standpoint. However, we cannot ignore our emotions when it comes to money. 

Debt can be extremely stressful or overbearing. Because of this, there’s other options that take that into account. 

The right answer is subjective: it’s whatever you figure out is right for your situation. 

All of the options below will produce good results. That’s because any time you put a focused effort into moving more cash flow into your debts, the better results you’ll have. And consistent action is always a winning strategy. When you align your actions to a clear, concise goal, then that makes the results even better. 

My relationship with debt

For me, getting out of debt as fast as possible was key. In my mind I had to pay off my consumer debt (my two credit cards) first. This was because this is the worst kind of debt and it carried the highest interest. 

To me it didn’t make any sense to keep this around any longer than I had to. After that I took that freed up cash flow and put it to my next highest interest loan. This paid off my debt quickly but also saved me the most in interest. I’ll go more into my full strategy after you’ve read through the options so it makes more sense. 

Remember, each option has a trade off. The fact that you’re picking and sticking with an option means you’ll be out of debt quicker. Not to mention feeling a lot better about it. Being unorganized and without a plan has a trade-off too: more interest and being in debt longer. 

Note that your scenario may encapsulate multiple options. If so, and it probably does, because personal finance is a complex mix between math, reason, behavior, and emotions. 

For example: if you’re in consumer debt at 22% interest and that’s your highest debt amount at $20k, and your other debt is a student loan for $10k at 4%, you’d simultaneously be using options 1 & 2.

With that being said, the options below aren’t really in much of an order. Read them all and see what makes the most sense for your situation. 

Debt Payoff Option 1: Highest Interest

This was the route I went as I noted above. This option is going to save you the most money in interest because you’ll pay off those debts with the highest interest first. From a pure financial standpoint I think this is the most optimal option. 

Typically credit cards also have the highest interest rates and I always advise people to pay down credit cards as fast as possible. This is due to the combination of consumer debt being: high interest, easy to get into, and the most emotionally overbearing (in my experience). 

Trade-offs for taking this option are that you may have a debt at 7% interest and one at 4% but the one at 4% is much larger and/or more of a burden emotionally. In that scenario you’d be sacrificing a small interest win for larger emotional baggage. 

Ideally this scenario is best used when you have credit cards that are in excess of 10% interest (the average is over 16% currently, even worse if your credit isn’t good – which is insane!!). 

National Average for Credit Card debt from 2007-2021

Debt Payoff Option 2: Highest Amount

Paying off your biggest value debt first can lift a huge burden off of your shoulders. 

I personally saw a lot of value in this when paying off my student loans. Once my credit card debt was out of the way, I decided to tackle my student loans which were, at the time, my highest total amount. 

For me I hated checking my balance online and seeing I owed a huge 5-digit sum of money. And it was supposed to take me 7 more years. That felt bad at the time. 

I wanted that cash flow freed up sooner than 7 years. So for me it was mostly an emotional decision that helped me to feel better about paying down my loans – and that’s totally fine. 

If you happen to get a windfall such as a small inheritance or a cash bonus at work, it could be beneficial to put it towards a large debt to decrease the mental burden.

When I think of this option, I think of people who take on very large loans of school. Think doctors or degrees that take over 4-years and that aren’t subsidized or given many grants for.

Debt Payoff Option 3: Lowest Amount

This is another great option in my opinion. By paying off your lowest value debt, you’re going to free up cash flow quicker. This is great for rolling more money into other debts and also creating a huge mental win when it comes to feeling like making progress.

If you have a debt that you can pay off in less than a year and one that’s going to take 5+ years, perhaps you’d feel better paying off the one that was less than a year and freeing up that cash flow. 

If you then roll your payment into the larger debt then you can pay it off in (probably) less than 5 years. This will significantly cut down your debt payment timeline.

For me this makes sense from a financial perspective but also from an emotional perspective. It creates a quick win and keeps you motivated all the while freeing up more and more cash flow – big wins here all around.

Debt Payoff Option 4: Most Emotionally Draining

Last but not least is the option that takes into account the worst debt to you. Which one weighs you down the most? Is there one that literally keeps you up at night? 

Maybe it’s that nagging student loan you’ve been paying on for a decade that doesn’t seem to go away because of the back-interest accumulated? Or it’s the car you really want to trade or sell but you’re underwater on the loan with.

For me this was credit card debt at first. Seeing the interest amount hit my account was depressing, once I started caring about it. 

After that it was the student loans because of the sheer huge value of them. It felt like I was going to be paying them back forever and that was a terrible feeling.

Some people can pay back long, small payment loans for years without a care – I envy you!

I am becoming more comfortable with debt again in my life currently. Due to my unhealthy relationship with it in the past, I was really avoiding it for the longest time at all costs. This was due to the emotional drain it created for me in my life at the time.

So, if you’ve got one that’s really draining, consider getting rid of it as fast as possible first.

Debt Payoff Option Combo: Stacking

Stacking your strategies or using multiple options to come up with the most optimal plan for you is a great idea. This is what I did to help pay off debt at the speed that was right for me.

I chose to go down the path of paying off the highest interest loan first. However, I had two credit cards, both with equally ridiculous interest eating me alive. Here is where I stacked option 1 with option 3. 

I wanted to free up the cash flow from the lowest amount first and roll it into the larger amount. Once both cards were paid off then I had two low interest loans: a car and my student loans (both within 2% of each other). At this point I chose to pay off the most emotionally draining, which for me was the highest amount. 

Once, I got a bonus at work as well and decided to put that towards the student loan to help drop it faster. Once it was paid off, the car got paid off pretty quick since I had so much free cash flow going to it. 

In fact, I was able to slow the payment down. This sounds counterintuitive to what I’ve said this entire time of paying off debt ASAP but hear me out… 

I was finally able to have enough free cash flow in my budget to be able to contribute to a company 401(k) plan that had a nice match. 

Since I was getting the match, it finally made it worth it to me to focus on. This was a big emotional win for me because I was highly motivated to start getting that match and begin my investing journey and I wasn’t in much of a rush to pay off my car at that point, knowing it would be paid off within the next 6 months or so anyway. 

As you can see I was kind of all over the place with my strategy. But at the time I felt the best going down this route. Was it the most optional plan ever? Did I pay the least amount in interest? Or pay it off fastest? I don’t know, but it felt like a really great mix of financially smart moves coupled with easing the burden and stressfulness of being in debt. 

How Will It Feel To Pay Off Your Debt Faster?

We can all agree that being in a lot of debt is no fun. Paying off the ones that are crazy high interest or emotionally draining can be a huge burden lifted from our shoulders. For me it was a mixed bag of emotions, depending on which part of the journey you asked me in. Saving money by paying less in interest is always nice. Removing emotionally damaging baggage is a huge plus for anyone trying to get their life in order.

At the end of the day we need to remember this is all about improving our relationship with money. This will allow us to enjoy life and strike the balance between fun and security for Future-You. It will also allow you to start accomplishing some of your longer-term financial goals. I assume most people reading this blog make pretty good money and are on the path to one day potentially be really wealthy. Therefore, congrats on taking the first step for a better future.

Here are ways to support, stay in touch, and work together:

I look forward to speaking with you and helping guide you down this life changing path.

In health and in wealth,

Seth