Option 1: The “high-interest first” strategy
Paying off high-interest debt first is commonly referred to as the avalanche method. This involves making the minimum monthly payments on all of your credit cards and loans, but putting every extra penny you can toward the card or loan with the highest interest rate.
Prioritizing debt by interest rate.
This repayment strategy, sometimes called the avalanche method, prioritizes your debts from the highest interest rate to the lowest. First, you'll pay off your balance with the highest interest rate, followed by your next-highest interest rate and so on.
Prioritize tax debt and collections
When it comes to paying off debts, you should focus on clearing tax debts and debts that are in collections. For instance, you might address tax debts owed to the IRS first because failing to pay can lead to severe consequences like wage garnishment or legal action.
But which one should you prioritise? When it comes to saving or paying off your debt, it's not as complicated as people think. The answer is simple: pay off your high-interest debts first.
The "snowball method," simply put, means paying off the smallest of all your loans as quickly as possible. Once that debt is paid, you take the money you were putting toward that payment and roll it onto the next-smallest debt owed. Ideally, this process would continue until all accounts are paid off.
In general, paying off your credit card debt in full is the optimal solution that preserves your credit score and history. However, it may not always be feasible to afford paying the total balance owed, especially with high interest rates compounding the problem.
The Best Ways to Pay Off Debt
Debt consolidation, the debt snowball method and the debt avalanche method are some of the best ways to tackle debt, especially if you have high-interest credit card balances. Here's what you need to know about how each strategy works and when to consider it.
Key takeaways. Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
It's best to tackle tax debt and debt in collections first to avoid legal issues. After that, consider these strategies: Prioritize debt with the highest interest rate. Focus on debt with the smallest balance.
Pay Off High-Interest Loans First
With this approach, you pay off your loans from the highest interest rate to the lowest. You make the minimum payments on each balance except the highest-rate loan. You also make an extra monthly payment based on how much you can put toward the debt.
Here are some guidelines that can help you decide which bills you should pay first. Paying for food, child care, and essential medicine should be your first priority. You should always be a good steward of your money and spend wisely here. Don't overspend for food and unnecessary medicine.
With the debt avalanche method, you order your debts by interest rate, with the highest interest rate first. You pay minimum payments on everything while attacking the debt with the highest interest rate. Once that debt is paid off, you move to the one with the next-highest interest rate . . .
Is $5,000 a lot of debt? The answer will depend on your credit limits. If you have $10,000 in available credit across two cards, then your utilization is 50%, which is a bit high and can hurt your credit score. But if you have $20,000 in credit across three cards, you're only using 25%, which is in a healthy range.
Consider the snowball method of paying off debt.
This involves starting with your smallest balance first, paying that off and then rolling that same payment towards the next smallest balance as you work your way up to the largest balance. This method can help you build momentum as each balance is paid off.
If you do it right, debt consolidation might slightly decrease your score temporarily. The drop will come from a hard inquiry that appears on your credit reports every time you apply for credit. But, according to Experian, the decrease is normally less than 5 points and your score should rebound within a few months.
Every dollar counts. Once you pay off that credit card or other high-interest debt, put the money you were paying on your highest interest debt—the minimum plus the little extra—towards the debt with the next highest interest rate. Work your way down the list until you're debt-free.
The debt avalanche method involves paying off your highest-interest debt first. To do this, you'll make the minimum monthly payment on every card or loan you have, except for the debt with the highest interest rate. Then, you'll put all your extra money toward paying down that balance as much as possible.
HIGH PRIORITIES
Pay for your family necessities including food and essential medical expenses. Pay your mortgage or rent. If you own your home, pay real estate taxes, insurance, condo fees and mobile home lot payments. Failure to pay these bills may lead to a loss of your home.
Credit Score Damage: One of the major downsides of debt settlement is the negative impact on credit scores. The process can lower a credit score by 100 points or more, depending on the individual's credit history. This can make it harder to qualify for credit, loans, or favorable interest rates for several years.
In a Nutshell
Though there's no set timeline, you can expect legal action after six months of nonpayment. While there are no guarantees, you're less likely to be sued if you owe less than $2,000.
Debt settlement is likely to lower your credit score by as much as 100 points or more.