Which Debt Should Be Paid Off First?

Highest Interest First

Most debts have an interest rate on the principal outstanding balance. This principal balance grows as any interest accrued during the lifetime of the debt is added to the outstanding amount. Some people prefer to focus on paying back debts with the highest interest rates first. Minimum payments are paid on all debts and an additional payment is made on the debt with the higher interest rate. When considering two debts of identical sizes but with different interest rates, paying back the debt with the higher interest rate will result in a reduced total debt.

The debt-snowball method is when the smaller debts are paid back first, with the intention of paying back the larger ones later. In addition to paying the minimum payment amount on each debt, an extra sum is paid towards the smallest debt. Once the smallest debt is repaid, the second smallest debt is repaid. The second smallest debt is repaid by paying the minimum payment on that debt, plus the minimum payment normally reserved for the smallest debt, plus any extra sum available. This "snowball" effect continues until all debts are repaid in full.

The ideal debt repayment strategy depends on the nature of the debts owed. Some people may have many debts of similar size, but with varying interest rates. Others may have multiple debts of different sizes, but with similar interest rates. The debt-snowball method is often recommended for those with multiple credit card debts as well as debts with similar rates of interest. Many people prefer this method as it gives them the satisfaction of clearing a whole debt completely, which encourages them to repay other debts later on. Repaying debts with the highest interest first, however, results in debtors with more money in their pockets when all debts are cleared.

Some people may find the above debt repayment strategies unfeasible, especially with debts that are either late or have spiraled out of control. A Debt Management Program, or DMP, may reduce the burden of such situations. DMPs are managed by a third party who will in turn stipulate new repayment terms. Another option is debt consolidation, where many debts are rolled into one, larger debt. Care must be taken with debt consolidation, especially with debts that have different interest rates. Debtors may find that they are in fact paying more interest in the long run, even though monthly repayments have been reduced.