Paying off debt can be fairly straightforward if you have only one or two creditors. If you have taken out multiple loans or hold balances on several credit cards, eliminating debt is more complicated. You will want to choose a wise payment strategy to avoid incurring more interest than necessary. Here’s an explanation of which popular debt payment strategies to follow, and which to avoid.
Paying the Minimum on All Your Debts
With this strategy, you make the minimum payments on all your debts each month. Meeting the minimums is crucial to avoid penalties, late fees, and legal trouble. However, paying the minimums and nothing more causes you to owe more interest and lengthens the time it takes to eliminate your debt. Paying off debt this way is not ideal.
If you have little or no money left over each month after paying your living expenses and the minimums on your debts, then you likely cannot afford to pay more. It is far better to pay the minimums than nothing at all, but if you have money left over, it is wise to choose a more aggressive payment strategy to reduce your debt faster.
Paying Off the Lowest Balance First
With this strategy, you first meet your minimum obligations for the month. Then you use the money that’s left over to pay off the debt with the lowest balance. Once you pay that off, you focus on the debt with the second-lowest balance, and so on until all your debts are paid. While effective, this may not be the best strategy; it can lead you to delay paying down large debts with higher interest rates, which should be a more urgent priority. People sometimes find this strategy tempting because it quickly reduces the number of debts they must keep track of, even though it does not effectively reduce the interest they owe. If you’re struggling to keep track of multiple accounts, a better solution is to speak to a nonprofit credit counselor and to enroll in a debt management plan with a single monthly payment.
Making Small Additional Payments on All Your Debts
People following this strategy first make their minimum payments, then use the remaining money to make an additional small payment on each debt. For example, someone with 10 debts and $150 left over each month would pay an extra $15 toward each debt. This is still not ideal because, like the previous strategy, it does not focus on debts with high interest rates. Those debts should be paid off as quickly as possible, instead of being paid at the same rate that you pay lower-interest obligations.
Prioritizing Debts with the Highest Interest Rates
When you follow this strategy, you first pay the minimums on all your debts. You then use the remaining money for the month to pay the debt with the highest interest rate. When that’s paid off, you direct the remaining money toward the debt with the second-highest interest rate, and so on. This way, you first focus on paying off high-interest obligations, then shift toward lower-interest debts when the high-interest ones are paid. This is the best strategy you can follow because it minimizes the interest you owe. If you are able to pay more than the minimum amounts, this strategy may save you money in the long term, especially if you successfully avoid accumulating new debt during this time.
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