Question: What Debts Should I Pay Off First?

"My wife and I have decided that with our current income levels and some proper budgeting we could get out of debt on our own, but we're not sure where to start with all the debts we have. Which should we pay off first?"

This really depends on a debtors personal situation. Should you pay off the smallest loan first or start with the debt that has the higher fees and interest rate? In the long run paying off the debt with the highest interest rate will put more money back in your pocket. But, paying off the smaller loans will help with your credit score and maybe help you feel better in terms of paying off the debts. It really depends on the person, the debt amounts and the interest rates on these debts. To help sort it out, try the following:

Step 1.

Start off by listing all your unsecured debts from the highest to the lowest interest rate. Don't include secured debts because it's not really an option to not pay these debts regularly on a monthly basis. On the top of the list you will probably have your credit cards, as they tend to have the highest interest rates. If any of these debts are fairly new credit cards, make sure you use the real interest rate - not the introductory rates if offered. For example:

Student Loan A8.5%
Student Loan B6%
Line of Credit4%
Step 2.

Beside this list, or in another column if you're working on a spreadsheet - add the minimum monthly payment for each debt. For example:

Visa - 15%$225
Mastercard - 11.5%$156
Student Loan A - 8.5%$205
Student Loan B - 6%$125
Line of Credit - 4%$352

This means that you need $1063 each month just to make the minimum payments for these debts. Now obviously you will need to pay more then that or you will never be debt free but which debts should get the extra attention? The worst thing you can do is pay a little extra off on each debt every month. All this will do is keep the creditors happy because you will be paying more to them in the long-run.

Step 3.

Continue to make the minimum payments for each debt and put as much extra income as you can towards the highest interest debt first, in this case the Visa at 15%.

If one or two of the other loans are small enough you may decide to pay those off first, as it will give you a sense of accomplishment and reduce bill clutter. If you can't afford to pay that much extra each month then perhaps it's time for you to set a budget in order to eventually become debt free.