September 22, 2018
From credit cards to student loans, home repair bills to car payments, debt can keep homeowners up at night. But of course, not all debts are created equal. If you’re looking to tackle your debt, which debts should you pay off first? The answer will depend on you—specifically, your motivations, your behavior, and your goals to determine your debt repayment ability.
Like any big goal, in order to make progress, you need to know where you’re starting from and where you want to go. First things first: How much debt do you actually have?
“I recently worked with couple that had a bunch of small loans,” says Crystal Rau, a certified financial planner™ professional (CFP®) based in Midland, Texas. “They like to go out to eat, travel, and shop, and that adds up. When I sat down with them and actually showed them what they were spending [each month], it really blew their minds.”
The more you know, the more you can make progress. Tally up your debts: List them out by amount, interest rate, and how the balance is calculated. That initial understanding enables you to then take stock, prioritize, and make a plan and budget to pay off your debts.
When it comes to homebuying, many people think “I bought a house, I feel good,’ but this does not change people’s behavior,” says Nandita Das, professor of finance at Delaware State University and a registered investment advisor. “Read carefully what you’re signing and prioritize your debt.”
Consider your behavior, your priorities, and what would best set you up for success: Are you the type of person who needs to see short-term progress to stay motivated? Or do you prefer to take the long view and work toward a big goal?
Next, select your debt payoff approach, particularly the popular avalanche versus snowball methods to pay off debt. With the avalanche method, your highest-interest debt gets top priority to pay off first. Once that’s paid off, move on to the next-highest interest debt, and so on. This method is good for long-term planners or those who like to work toward a big goal.
With the snowball method, first focus on your smallest-balance debt obligation and eliminate that loan first. When that bill is gone, tackle the next-smallest debt amount, and so forth. This method appeals to homeowners who like to see small wins to stay motivated.
“The ‘avalanche versus snowball’ question really asks whether absolute dollar terms are more important to the [homeowners], or psychological wins,” says Greg Knight, an Oakland-based CFP®. “In absolute dollar terms, go with avalanche and shift extra dollars to the highest-interest rate debt first. If absolute dollar terms are not as important and they need the satisfaction of feeling like they are ‘winning,’ then use snowball to wipe out a few small debts.”
(And it goes without saying: With either scenario, make sure you still pay the minimum monthly payments on all lower-priority debts!)
So, are you an avalanche, a snowball—or some combination of the two?
Celebrate small wins and be compassionate throughout the debt payoff process. Progress can take many forms along the way.
“If you have a bad month, circle the wagons and get back on track,” says Knight.
Because life happens and circumstances change, a successful debt repayment strategy can also benefit from regular check-ins.
“Me and my husband do bi-weekly money dates,” Rau says. “Twice a month, we sit down and track our goals and see if there’s anything that needs to be adjusted, and it’s really helpful. Just seeing progress every few weeks can keep you motivated.”
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