Which Debts Should You Pay Off First?

And Which Debts Are People Paying Off?

Which Debts Should You Pay Off First?
August 17, 2017

What's your strategy for paying off multiple debts? Do you simply pay what you can whenever the monthly bill or statement arrives, focus on one bill at a time, or attack high-interest debt first? Do you even have a strategy at all?

There is no single "right" way to pay off your debts – It depends on your goals and priorities. For example, if you are interested in saving the most money over the long run in interest charges, make the required minimum amount on most payments and devote your extra funds toward paying down your debt with the highest interest rate (usually credit cards). If you prefer an early "win" to give you momentum, pay the smallest debt first.

According to a recent report from the credit bureau TransUnion, Americans have chosen an interesting priority in their loan payment strategy. TransUnion studied consumers who were current in their payments with four different kinds of debt: an auto loan, credit cards, a mortgage, and an unsecured personal loan. Currently, unsecured personal loans appear to be the top priority of Americans.

Personal loans had the lowest delinquency level of all four loan types. Auto loans came in second, mortgages finished third, and credit cards had the highest delinquency rate of all. This is the first year where unsecured personal loans were included in the TransUnion study, and the researchers were surprised to find them at the top of the list.

Historically, the priority order in TransUnion studies has been auto loans, mortgages, and then credit cards. Auto loans and mortgages are secured loans, meaning that the lender has the ability to repossess the car or home for non-payment. Credit cards are unsecured revolving credit (meaning the balance changes and continues indefinitely as charges are added). Unsecured personal loans are installment loans similar to auto loans and mortgages, but they have no associated asset that can be repossessed. If you are interested in a personal loan, visit our curated list of top lenders.

Traditionally, secured debts should be addressed first because of the potential risk of losing the underlying asset (home or car). However, unsecured loans are typically small and the loan terms are normally short – 28 months on average for loans taken out in Q4 2016, considerably shorter than the sixty months found with auto loans and 230 months of mortgages. It could be that Americans are following the quick win strategy and trying to eliminate a single debt first.

Auto loans have always been the top priority in the past, likely because of necessity. Unless you live in an urban area with excellent public transit, you probably need a car to get to your job and earn the money necessary to pay all your bills.

What's your best strategy for paying down debt? Decide on your order of priority, starting with any necessities – if your house or car is in danger, you must make steps to protect it or seek alternate transportation and shelter. Pay the minimum on all debts to avoid penalties, and devote the excess funds to paying down one debt of your choice. Whether it's the largest or smallest balance, highest interest rate, or the shortest term, attack that single debt until it is gone and move on to the next one.

The key phrase above is "excess funds." If you don't control spending to stay within a proper budget, you won’t have any excess funds to use in paying off debts – therefore, your priority doesn't matter. Your debts will never be paid.

If you can't decide the best path, seek the guidance of a qualified financial professional. It's not always easy to look at your financial situation honestly, and with unbiased expert help, you can craft a plan that best fits your needs.

If you want to reduce your interest payments and lower your debt, join MoneyTips and try our free Debt Optimizer tool.

Photo ©iStockphoto.com/maselkoo99

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