If you have multiple debts at different interest rates, you have a difficult choice in front of you: which debts should you try to pay off first?
There are two big philosophies out there, each with its own advantages and disadvantages.
The first philosophy argues for putting all your extra money towards the your debts with the highest interest rates first. This is called the debt avalanche method, and its main advantage is that it saves you the most money over the long-term. After all, it’s your highest interest rates that are costing you the most, so from a purely mathematical standpoint it makes sense to get rid of them sooner.
The second philosophy argues for putting all your extra money towards your smallest debts first. This is called the debt snowball method and it’s been made especially popular by Dave Ramsey. The argument here is that the motivation provided by paying off those smaller debts encourages you to keep going, and there is research out there that backs it up.
I’m not going to get on a pedestal and preach the virtues of one over the other. The most important thing you can do is find an approach that works for you and stick with it consistently. One way or another, pay off those debts.
But when I’m asked for advice, I like to recommend a hybrid of the two approaches. Here’s how it works.
Step 1: Pay the minimums on everything
This is pretty simple but it needs to be said: before deciding on anything else, you need to make sure that you pay at least the minimum on all of your debts, no matter what.
There are plenty of reasons for this, but the big one is the impact on your credit score. Making all your payments on time is the single biggest factor in your score, and if it ever got so bad that one of your debts was sent to collections, that would be a major knock against you.
Set those minimum payments on auto-pay if you can, but in any case make sure they’re handled before moving on.
Step 2: Find a quick win
If there are any debts you can wipe out within the next 3 months or so, handle those first.
Success provides very real motivation, and I absolutely believe it’s worth finding a quick win out there if you can. That success will show you that it’s possible, and you’ll feel the relief of having one less debt to worry about.
Step 3: Avalanche the rest
Once you get that quick win, or if there isn’t a quick win to be had, I would switch to the debt avalanche approach.
Sort all your debts by interest rate and put all your extra money towards the one with the highest rate. Once that one is paid off, put your extra money towards the next highest interest rate, and so on until they’re all paid off.
The reason is simple: it’s the best financial decision. Paying off your highest-interest debts first will save you the most money over the long-term, and in some cases it may save you thousands of dollars over paying your smaller debts first. That’s a big deal!
With that said, I still like the idea of setting little goals along the way and recognizing when you’ve hit them. You can do something like celebrate every $500 paid off, or you can simply celebrate every month where you make an extra payment. There’s plenty of progress to recognize even if you aren’t paying off a debt in full, and that progress can help you stay motivated to keep going.
Here’s a free tool that will help you do this as easily and efficiently as possible.
Find your own way
This is the way I like to do it. I think it gets the best of both worlds by giving you some quick motivation while still helping you get the best financial outcome. It’s a win-win.
But in the end, the most important thing is that you find a way to pay off your debts that works for you. If you’ve had success with a different approach, let me know in the comments! It’s always fun to learn something new.