In What Order Should Debts Be Repaid?
There are two popular approaches toward paying off multiple debts:
- Higher interest rates first. This is the mathematically optimal approach, since it results in paying the minimum amount of interest.
Suppose you've got one loan at 10%, another at 18%, and a third at 4%. Under this approach you'd want to focus your money on the 18% loan until it's paid off, then work on paying off the 10% loan. Continue making only minimal payments on the 4% loan until it's finally paid off; this isn't high-interest debt, so your money's better off invested elsewhere.
This is the technically best approach, but it can be psychologically difficult. Suppose the 18% loan has a balance of $120,000, while the 10% loan is only for $1,500. It's hard to throw money at a big debt, month after month. You may not feel like you're making much progress, and if you're too disheartened you may give up. That's the worst outcome.
- Lowest balance first. This isn't as optimal, but it may be more emotionally satisfying.
This is also known as the “debt snowball” approach, popularized by Dave Ramsey. With this scheme, you'll pay your smallest high-interest debt first, then use the money freed up from the minimum payments to pay off the next smallest debt, and so on.
This approach isn't mathematically optimal—you'll pay more in interest—but many people find it easier to stick with it.
Both of these approaches are effective. Choose the one that works for you. I'd suggest giving the first strategy a shot, since it's technically the better choice, but give yourself permission to switch to the second strategy if you feel disheartened.