Paying off personal loans: which loans should you pay off first?
It can be overwhelming to look at your monthly debt payments and think that there’s no way out. But there are many ways to attack that debt, one of which just might work for you.
So which debts should you start with? Here are a few recommendations from experts in the field.
Types of debt matter when deciding what to pay off
Even though any sort of debt might seem negative, there is a difference in good and bad debt. Debt.org explains that a simple rule is this: “If it increases your net worth or has future value, it’s good debt. If it doesn’t do that and you don’t have the cash to pay for it, it’s considered bad debt.”
Knowing this is key when deciding which loan you should attempt to pay off first. A good example is student loans versus personal loans. Even though both need to be paid quickly, personal loans might have a higher interest rate and be considered “bad.”
Debt avalanche or debt stacking: what are they, and why are they so helpful when paying off debt?
NerdWallet.com says, “A debt avalanche (also known as “debt stacking”) is likelier to pay off debts in a shorter time and save you the most money on interest. This payoff method targets debts with the highest interest rates first.”
In other words, tackling the loan with the highest interest rate by paying as much as you can over the minimum monthly payment will help you get out of debt faster. And Creditkarma.com says, “Once you have paid off this loan, you should focus on the debt with the second-highest interest rate and repeat the process until all debts are gone.”
Other debt-payoff methods to know about
The debt snowball method accelerates your payments as you work from smallest to largest
This same NerdWallet article explains that a debt snowball plan, in contrast, prioritizes your smallest debt first no matter the interest rate. When the smallest one is eliminated, you move to the next larger, and so on until your debt is gone. A key part of the plan is that you pay whatever you were paying on the two lowest bills and now pay that on just the new lowest bill. The further up the list you go, the faster you pay down, all while using the same amount of money each month that’s earmarked for debt reduction.
According to Credit Karma, “as each debt is paid off, the money that was used for the previous debt is “snowballed” and used to pay the next smallest debt. This process is repeated until all debts are gone. Even though this strategy might not save you as much money on interest fees, some people find it motivating to pay off one account at a time.”
The snowflake method takes all available money to pay off debt as quickly as possible
According to Nerdwallet, the snowflake method, on the other hand, “finds tiny, day-to-day savings and uses them to make your zero-debt day come even sooner. It’s compatible with either the snowball or avalanche strategies. Like snowflakes, tiny savings collected over time can have a big impact. And you have to be quick to capture them: Snowflakes disappear fast.”
Which loans weigh heavier on my credit score?
A recent article from The Balance explains that new and existing loans can affect your credit report in different ways:
- They help you build credit if you successfully make payments.
- They hurt your credit if you pay late or default on loans.
- They reduce your ability to borrow (which might not directly affect your credit scores).
- They cause slight damage to your credit at first, but they can easily recover if you make payments on time.
It’s also important to consider that paying off your debt will not necessarily immediately improve your credit score, as this will result in having fewer open accounts. Click here to learn why your credit score could potentially decrease after paying off debt.
How do I know which mothod of debt payoff is right for me?
Your unique financial situation will determine the best method to choose when paying off debt. When making a decision, consider your income, your credit score, your monthly minimum payments and how much you’re paying in interests. And be sure to consult a trusted financial advisor.
LendingPoint is a personal loan provider specializing in NearPrime consumers. Typically, NearPrime consumers are people with credit scores in the 600s. If this is you, we’d love to talk to you about how we might be able to help you meet your financial goals. We offer loans from $2,000 to $25,000, all with fixed payments and simple interest.