Strategies for Managing and Prioritizing Debt

Effective Methods to Tackle Different Types of Debt

Facing a mound of piling debts each month can be an exhausting process. You might be tempted to throw chunks of your paycheck at your auto loan one month, and then feel an urge to peel away a layer or two of your student loans the next. Or, you might be paralyzed by the staggering amount of open accounts on your credit report and decide it's better to do nothing. 

Maybe, just maybe, if you’re quiet enough for long enough, your creditors will forget about you, and you can ride out the statute of limitations.That might sound like an interesting strategy, but it’s a dead-end street. We don’t recommend it. Instead, you should pay off your debts while keeping in mind how certain loans will actually benefit you, while others will only drain your energy and strain your bank account.

The Importance of Strategic Debt Repayment

When you repay debt strategically, it does not have to be a game of Russian Roulette. On the contrary, it can be more like a nice, slow game of chess where you eliminate pieces of debt one by one until you’re victorious.

How to Prioritize Debt

There are certain loans that the government actually wants people to take out, such as mortgages and student loans. When people buy a house or go to college, it means more homeowners and a more educated population.

This is good for the economy and the nation. That’s why the government is willing to offer tax breaks on these loans. These are loans you may want to take your time paying back.

Some people refer to this as “good debt,” while others think there is no such thing as good debt. To keep things simple, we’ll just say (barring abnormally high interest rates) mortgages and student loans are lower priority debts. In other words, it’s OK to take a decade or longer to repay these debts, especially if you have other more pressing or bank-draining debts on the horizon.

That being said, there is no one-size-fits-all prescription for getting out of debt. There are, however, factors every consumer must consider when weighing the pros and cons of repaying certain debts before others.

Factors to Consider When Prioritizing Debt Repayment

1. Tax Breakssome text
   • Tax breaks can come in the form of credits, reductions, or exemptions. Certain loans, like mortgages and student loans, are tax deductible and allow you to reduce your taxable income.
   • For student loans, you can deduct up to $2,500 in interest paid. For mortgages, you can deduct all of the interest on a loan worth up to $750,000.
2. Interest Ratessome text
   • Certain loans almost always have higher interest rates than others. Student loans and mortgages have average interest rates of 3% to 7.5%.
   • Good luck finding a credit card with single-digit interest rates; even with a perfect credit score, consumers would be hard-pressed to find a credit card with a lower interest rate than 14%. The average credit card interest rate is actually a bit higher at 19% as of 2019.
   • Personal loans have the most volatile interest rates, fluctuating from as low as 5% to as high as 36%, sometimes higher. If your loan comes attached with an interest rate above 36%, this may be a sign you’re dealing with a predatory lender.
3. Remaining Balancesome text
   • Unless you win the lottery, you’re not going to repay your mortgage in a year. You can, however, repay that $500 medical bill or that $1,200 high-interest credit card. Repaying smaller debts can fill you with a sense of accomplishment, providing the momentum needed to endure (and eventually take down) the larger ones.
4. Consequences of Defaultsome text
   • The loans with the direct consequences of default should be higher on your to-do list. Missing enough mortgage payments will land you on the street. Dodging child support payments or evading taxes could land you behind bars.
   • There are no good consequences of default, so this part can feel like choosing between the lesser of two evils. Still, anybody can overcome a bad credit report or bounce back from bankruptcy. It’s a lot harder to regain financial stability without a roof over your head.

Strategies to Pay Off Debt

There are two popular schools of thought when it comes to paying off debt.

1. Debt Avalanche Methodsome text
   • This method targets high-interest debts first. By paying off debts with the highest interest rates, you minimize the amount of interest you pay over time, which can save you money in the long run.
2. Debt Snowball Methodsome text
   • This method eliminates smaller debts first, regardless of interest rate, before gearing up to take down the larger ones. The psychological boost from quickly paying off smaller debts can provide the momentum needed to tackle larger debts.

Conclusion

Prioritizing debt repayment is a crucial step in achieving financial stability. By considering factors such as tax breaks, interest rates, remaining balances, and consequences of default, you can develop a strategic plan to eliminate debt efficiently. Whether you choose the debt avalanche method or the debt snowball method, the key is to stay consistent and focused on your financial goals.

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