What Debt Do You Pay Off First?

It’s a common question when paying off debt—Should I pay the debt with the highest interest rate first since it costs me the most money?

Short answer: No. But we’ll explain. It’s best to start with the smallest balance. Here’s why.

Build Momentum

Let’s say you have debt that looks like this:

$6,000 car loan at a 5% interest rate
$3,000 student loan at a 5.5% interest rate
$9,000 credit card bill at a 14% interest rate

At first glance, it seems like it would make sense to start with the debt that has the highest interest rate. But it’s actually better to start with the lowest debt. So, in this example, you’d list your debts in the following order:

$3,000 student loan
$6,000 car loan
$9,000 credit card bill

The reason is behavior change. When you concentrate on the smallest debt first, and throw every extra bit of money you’ve got toward paying it off (after making the minimum payments on your other debts), you’ll start to see major progress. For example, say your minimum payment for that student loan is about $32 a month over 10 years. If you budget your money carefully and you’re able to add $250 to that payment each month, you’ll pay off your student loan in 12 months rather than 10 years.

Then after one year, your debt list will look like this:

$3,000 student loan
$6,000 car loan
$9,000 credit card bill

One debt down, two to go!

When you quickly pay off your lowest debt—the student loan in this case—it fires you up and gives you momentum. Being able to mark a $3,000 debt as paid gives you the confidence that it takes to tackle a $6,000 debt. You see that you’re making progress on your debt, and you want to keep working to pay it off.

Why It Doesn’t Work the Other Way

Starting your debt payoff with a $9,000 high-interest credit card bill doesn’t give you that same sense of progress. Don’t get us wrong—paying off all debt is important. But you need quick wins at the beginning to boost your motivation and encourage you to keep going.

Keep the Momentum Going

As you eliminate your debts, you can roll the old payments on to your next debt. That $282 that was going to your student loan, for instance, can now go toward your car loan. By the time you hit your final debt, you have a larger amount of money to throw at it!

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