If you’re in thousands or tens of thousands of dollars in debt, it can feel very overwhelming, sometimes to the point where you don’t know what to pay off first. Credit card debt, student loans, a car payment, a medical bill in collections – if you’re sinking into the quicksand of debt and interest rates, where do you start? What debt should you tackle first with the limited money that you have and what can wait?
Whether you’re in the hole by $1,000 or $100,000, here’s a suggestion for how to prioritize your money when you’re paying off debt:
Pay off the toxic debt first: Toxic debt is any rotating debt that’s accruing interest at a high rate. Credit card debt definitely falls in the toxic debt category. If you have a $1,000 outstanding credit card balance and you’re only paying the minimum on that amount, it will take you years to pay off that debt – and you’ll pay nearly double the original balance in interest. If you’re deciding which debt to pay off first, get aggressive with that high-interest credit card debt. Then you can move on to your other outstanding debt.
At the same time, handle any debt that’s in collections: While you tackle your toxic debt, be sure to start resolving any debt that’s overdue and now in collections. Any debt you have that is in collections is negatively impacting your credit score, so make sure that you have a plan to repay the debt with the collections agency as soon as possible. Start by calling the collections company and talking to a representative about your repayment options. If the balance is relatively low, you could even settle the debt over the phone when you call.
Consider the debt snowball for any installment loans: If you have any installment loans, like student loans or a car loan, you may want to consider repaying them back using the debt snowball strategy. This strategy means that you tackle the loan with the lowest balance first. Once that loan is paid off, you rollover that payment amount to your other outstanding debt, creating a snowball effect. While the debt you pay off first may not have the highest interest rate, it’s a great way to build positive momentum around paying off your debt.
Don’t forget about saving money: Even though your money and your financial energy will be dedicated to tackling your debt, don’t neglect your savings. If something unfortunate happened – like you lost your job – you’ll want to make sure that you have a cash cushion to get you through the tough times. Having at least $1,000 in an emergency fund in case something unexpected happens is a good place to start, especially if you’re paying down a lot of debt. Also, don’t forget to continue contributing to your retirement plan. If your employer offers a match to your retirement savings, you’ll want to make sure you’re taking advantage of as much of that free money as possible.