Total consumer debt reached a record-breaking $14.3 trillion at the beginning of 2020, according to the Federal Reserve. To put that 14-figure number into perspective, a recent Experian study found the average person had over $6,000 in credit card debt in 2019.
Those who have carried significant debt know how stressful it can be to live with this extra financial weight, especially if you carry multiple types of debt. We asked five experts to weigh in on what you should pay off first.
Before You Start
All five experts we spoke to emphasized the importance of having a baseline level of savings before tackling debt head-on. Often called an emergency fund or rainy day fund, these savings can shield you from the worst consequences of unforeseen expenses.
Many personal finance gurus tend to recommend saving three to six months’ worth of expenses for an emergency, but if that’s not achievable right now, then working toward even $1,000 or one month of expenses is better than nothing.
Bernadette Joy, founder of Crush Your Money Goals and who paid off $300,000 of debt in three years, always recommends starting with one month of expenses as a baseline. “I consider it a severance package to myself,” she says. “I know I have 30 days for mental clarity.”
Putting all of your funds toward debt before you have savings could end up setting you back. Without savings, an emergency like an injury or your car breaking down could put you into further debt.
This is not to say, of course, that you should stop paying off debt entirely until you get an emergency fund. “You want to be making minimum payments at the very least,” says Tracy East, director of communications at Consumer Education Services, Inc, a nonprofit debt counseling firm in Raleigh, North Carolina. It’s important to continue making payments to buoy your credit history and show you’re a reliable borrower.
Choosing Your Debt Payoff Strategy
Experts tend to fall in competing camps over what debt payoff strategy works best.
The debt avalanche approach is when you first focus on paying off the debt with the highest APR (annual percentage rate, which is the interest rate plus lending fees). Then, once that is paid off, you move onto the card or account with the next-highest APR. This method results in the most amount of money saved in interest, and generally, this method prioritizes credit cards and personal loans over student loans, which often have the lowest interest rates of any type of debt.
Paying off debt with the highest APR or balance first is also a good way to help your credit utilization ratio, says Jennifer Streaks, personal finance expert and author of the book, “Thrive!…Affordably.” If your credit card limit is $3,000 and you have a $2,500 balance, it will hold back your credit utilization ratio, which indicates how much of your available credit you’re using. “It makes it look like you’re not using credit responsibly,” Streaks says.
Make sure you have an emergency fund, or at least a month’s worth of expenses saved, before you settle on a plan to pay off your debt. Whatever method you choose to pay off your debt, make sure it aligns with your lifestyle and is something you can stick with for the long term.
On the other hand, the debt snowball approach prioritizes the account with the lowest balance, before moving on to the account with the next-lowest balance. While you will pay more in interest charges over time with this method, a quick win early on can be an effective motivator, says Kimberly Zimmerman Rand, principal at Boston financial counseling firm Dragonfly Financial Solutions LLC. “People I work with really responded to that feeling of accomplishment.”
Which approach is best for you is more of an “emotional decision” than a “dollar and cents decision,” Rand says. What works for one person might not work for another.
Bernadette Joy once worked with a client who had personal loans, credit cards, student loans, and money owed to a family member.
The debt snowball approach Joy typically recommends would have her client pay off the debt with the lowest balance, but in this case, the larger family loan was putting strain on the client’s personal relationships. Joy said she worked with the client to prioritize the family loan. “I personally will always choose relationships and people important to me [over money].”
Sticking With It
Short of a sudden cash windfall, there are no quick fixes to debt repayment. Paying off debt requires changing your life habits and relationship to money as a whole. “The biggest mindset change is switching from seeing debt as a solution to seeing it as a problem that you want to resolve,” says Jackie Beck, debt expert and creator of the money app Pay Off Debt by Jackie Beck.
“You didn’t get into this overnight, and you won’t get out of it overnight,” says Streaks. Be patient with yourself if you mess up, and don’t be afraid to ask for help. Tracy East from Consumer Education Services, Inc suggests speaking to a nonprofit credit counselor from the National Foundation for Credit Counseling or another nonprofit if you find yourself overwhelmed and unsure how to move forward.
Depending on the amount of debt you have, it may feel like an arduous journey, but achieving financial stability and a positive relationship to money will be worth it in the long run. You can’t put a price on peace of mind.