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There are several ways to prioritize high-interest debt payments. At the end of the day, it comes down to what works best for you. If you’re choosing to attack high-interest debts first, you’re likely highly motivated to save money on interest payments. So, take that motivation and dive right in with these tips for prioritizing your high-interest debt payments.
Tips To Prioritize High-Interest Debt Payments
Organize your debt by interest rate
Once you’ve identified all your debts and listed out the balance, minimum payment, interest rate or annual percentage rate (APR), and payment due date, you should organize your debt by interest rate.
The debt avalanche method focuses on paying down the high-interest debt you have and working toward the lowest-interest debt. But if you’re dealing with different types of debts and interest, you may want to consider those factors when developing a repayment plan. Using a debt payoff calculator also can help you figure out the best place to start.
Identify the type of debt you’re repaying
First off: is your debt revolving or installment debt, or some combination of the two?
Revolving debt refers to a balance you carry over from an account that lets you borrow against a credit line, most commonly credit cards. Installment debt, like auto loans, personal loans, and mortgages, refers to debt with a fixed amount that’s repaid in equal monthly payments. These payments include a portion of the principal as well as interest.
Credit cards tend to have the highest interest rates compared with other types of debt, though your credit score and other factors will determine your interest rate. The average APR on credit cards in the U.S. ranges from about 16% to 23%. Paying more than the minimum is just one way to pay off your credit card debt more quickly.
What kind of interest does your debt carry?
Does your debt have simple or compound interest? When you pay with a credit card, interest is added to your spending. But credit cards have compound interest, which means the interest is calculated based on the initial principal as well as the interest you’ve accumulated from previous payment periods. To put it simply, your interest gets charged interest.
Certain loans, like student loans and mortgages, also have compound interest, so if you make the same payment each month, interest will continue to build. In this case, it’s important that your payments are amortized—in other words, you pay off part of the interest in addition to the principal.
Simple interest, on the other hand, is more straightforward and applies to some loans like auto loans. You can calculate simple interest by multiplying the principal by the interest rate and the amount of time. So, if you have a $10,000 loan with an interest rate of 10% and a five-year term, the total interest would be $5,000.
While your credit card balance may be lower than your loan balance, the higher interest rate and compounding interest make it more unpredictable. If you can get a hold of your debts with compound interest before moving onto your debts with simple interest, you may be able to save more on interest in the long run.
Budget for payments
Regardless of how you decide to repay your debt, you should always budget for the payments. Evaluate your existing monthly budget and see if there are areas you can reduce or completely reallocate toward debt repayment. Try to avoid the urge to just budget for the minimum payment and tack on whatever’s leftover.
Instead, work that “leftover” money into your debt repayment budget so you’re not tempted to spend it. If you’re not able to come up with the extra funds or feeling completely overwhelmed, consider calling your creditor to negotiate a lower payment.