Which debts should you pay off first?

I had this question myself and the answer is not always so simple. Some will tell you it is the one with the highest rate. Others will say it is the one with the lowest balance. Both of these methods are good but you also have to consider the type of debt that you have. It can affect your credit score and ability to get future credit (such as a mortgage) if you need it.

Barring some insanely high interest rate or high payment I have come up with a priority order of what debts should be attacked first. I will give me reasons for each as well. The order in which you pay them off can have big effects on your finances as well as credit report. Here is my list:

  1. Credit Cards - Generally the highest interest rates plus rates and payment amounts can be adjusted at any time. Choosing the highest rate or lowest balance doesn't matter as much. These must be paid first in almost all cases!
  2. Unsecured personal loans - These are installment, fixed payment loans. Example: You borrowed $2,000 paid over 2 years from a bank for a laptop. Interest rates are usually higher on these.
  3. Auto and motorcycle loans - These loans are for depreciating assets and should be paid off next. Accelerating payment of these reduces the risk of having an accident where the car is rendered useless and you still have to pay the loan back.
  4. Student loans - Interest is generally lower on student loans than the above debts and the interest you pay is tax deductible. In a real emergency you can defer payments if needed.
  5. Mortgage and equity loans - These are usually the largest of all loans we carry and will take the longest to pay off. You have assets to back up this loan so it should be paid last. The interest on these loans is also tax deductible. Interest rates as usually lower than the above types as well.
Following the order above will ensure that you pay your debts off faster and in the correct order so that your credit rating will improve over time. Lenders like to see installment loans more so than revolving (credit cards) with balances when they decide to lend to you. You pay off your most expensive debts first using this method as well. You will be on the road to success!

I am currently working on steps 1 and 2 simultaneously. I am slowly digging out of my hole and soon will be able to accelerate my payments in the other areas. I recently paid off my smallest personal loan and can move to the next. It feels great to have one paid off!