From credit card payments to home loans, consumers often have several lines of credit to manage, which could make paying off debt overwhelming. By not being able to keep track of how much money you owe, you could be late on payments or even default on your loans. Since you have various types of credit and loans to oversee, it's crucial to know how to prioritize your debt to pay them off effectively and avoid late payments.
Here are five tips for prioritizing multiple sources of debt:
1. Add Up Debt and Take Home Pay
Before you decide whether you will put more focus on paying off credit card debt or student loans, look through all of your lines of credit and calculate the total of how much you owe. You may owe money for personal loans, mortgages, student loans, credit cards or auto loans.
According to Nerd Wallet's analysis of Federal Reserve data, consumer households had an average of $15,611 in credit card debt in December 2014. Student loan debt levels were even higher with an average of $32,264 in the same period. The biggest source of debt for U.S. households were mortgages with home loan debt reaching $155,192 on average in December. Knowing exactly how much debt you have for different loans can allow you to plan how you will tackle them for the future.
In addition, add up your take home pay to start determining how much of your income you can use to pay off your debt. Consider all sources of income, including extra money from part-time or freelance jobs.
2. Pay Off the Smallest Balance
As part of their debt reduction strategies, you could choose to pay off lines of credit that have the smallest balance. This technique is called the Snowball method, according to money management expert Dave Ramsey. The Simple Dollar said the snowball method works by making minimum payments of all of the debt you owe except for the highest priority debt – in this case the one with the smallest balance. After calculating how much money you can devote to paying off your debt, put as much money as you can toward paying off this small balance until it's paid off. Once this debt is gone, you can move on to the next highest priority debt down the list.
By paying off small balances first, you could gain the confidence to continue lowering your debt loads. Concentrating on eliminating specific types of debt allow you to reduce your balance without being overwhelmed at how much money you owe in total.
"By targeting accounts with high interest rates, you could save money."
3. Look at Interest Rates
In addition to knowing how much money you owe, it's crucial to determine what the interest rates are for each debt. While you might have a small balance for one account, a high interest rate could make monthly payments for it higher than those for high balance accounts with low interest rates. You can compare the interest rates for loans in the same category to see which one you should focus on.
By targeting accounts with interest rates that are higher than other lines of credit, you could save money. For example, the balance for Student Loan 1 could be $5,000 with an interest rate of 3.4 percent and Student Loan 2 has a balance of $4,000 with an interest rate of 8 percent. Although the average monthly payment for the loans will be almost the same at about $49 per month, you'll pay more interest over the life of the loan for Student Loan 2. You will pay more than $900 in interest for Student Loan 2 over a repayment period of 10 years compared to Student Loan 1. In this case, you could put more money toward Student Loan 2 and pay off your loans early, saving money on interest.
To help you calculate interest rates, use a debt calculator. Not only can these calculators provide a schedule for paying off debt, they can calculate whether you'll pay off your debt earlier if you put down extra money each month.
4. Determine Debt's Impact on Credit Score
Finally, look at the consequences of your debt in case you default or have a late payment. The impact of late payments could have more of an affect on your credit score depending on if the payment was for an installment loan or revolving credit. With the negative impact of late payments, paying off loans and credit lines on time is a significant part of maintaining good credit standing.