Deciding Which Debt to Pay First

Like many people, you’re probably juggling a variety of financial obligations and attempting to balance them out with limited funds. Yet while each debt is important, some are more pressing than others. Here’s how to decide which creditors to concentrate your efforts on. It’s all about logical prioritization, so pull out a pen and paper (or a spreadsheet, if you’re so inclined) and get started.

Step one: List your debts in random fashion

In no particular order, jot down every one of your creditors and the amount you owe to each. Be thorough. It may be a combination of a mortgage or vehicle financing (delinquent or in good standing), an unsecured bank loan, back taxes, credit card debt, payday loans, student loans, collection accounts, civil judgments, and money that you owe to friends and family members.

If there is an expected minimum payment, as for a credit card or installment loan, add that information in. Others, such as a collection account, may just be a lump sum obligation.

Step two: Determine what each is costing you

Next to each creditor, note the interest rate plus or any other associated fees. Calculate how much money hanging on to the debt is ruining you on a monthly basis.

For example, let’s say you have a credit card with an APR of 29% and the balance is $10,000. In that scenario, the interest alone costs you about $240 each month. Whip out a calculator and get those numbers for every creditor on your list.

Step three: Know what the repercussions for not paying are

I’m of the mindset that every penny you borrow should be repaid no matter who the lender is. That doesn’t mean, though, that all debts carry the same consequences if you were to walk away from them. So this step requires a bit of thought. Review each of your obligations and consider what would happen if you didn’t meet your payments on time, or at all. Write them down, again next to the creditors.

Here are a couple of examples.

You owe your pal George $200. He is not charging you any interest or fees, it’s highly unlikely that he’ll take you to small claims court for this balance should you renege, and he’s not sending negative information about it to the credit reporting agencies. Still, George is a valued friend and leaving him in the dust would certainly impair your relationship. That’s a consequence to consider.

On the other hand, you may owe $1,000 to a collection agency. You have no emotional ties to that company so paying them wouldn’t harm a friendship, but if you don’t make payment arrangements you run the risk of being sued, which will result in a judgment against you that will land on your credit report. The creditor may be allowed to garnish your wages, too, and the balance will be far larger because court and other fees will be added.

Step four: Re-order the debts

Now start to adjust the order of what you’ve randomly written it down. Try to be as rational as possible, weighing all the costs and consequences. This part of the exercise will take some time. Don’t rush it.

A large student loan that is about to descend into default will absolutely take priority over a small and current credit card bill. However, some won’t be as easy to order. You might have multiple personal loans and then have to figure out which loved one who helped you out in a time of need is more important in the great scheme of things. Is it better to keep a dentist bill out of collections or pay a credit card on time? In general, the answer to that question is yes, but call the credit card company and ask for a reprieve so you can avoid a ding.

Step five: Decide how much money you have to give

If you haven’t developed a budget so you know how much cash you have to send to your creditors, do so now. Subtract the total of your expenses from your net monthly income. Hopefully you’ll come out ahead with sufficient funds that you can use to send to all. If not, consider all of the ways you can realistically augment your income, decrease spending, or do a little of both. When you have a better number, you’re ready to distribute the money as per your determined priority list.

Imagine you have $700 left over that you can offer those you owe. Marvelous. With the list you created in step four, figure out who gets what for the next few months. On top may be a car loan that you have not paid in a few months because the bank is at the point of repossessing the vehicle. That debt gets $400. Second might be a bill where the lender is threatening a lawsuit if you don’t make a swift payment, and it gets $200, and third is the payday loan, which gets the final $100.

Step six: Reassess the list regularly

Eventually you will bring delinquent accounts current and pay others off entirely. That will leave you with more money to distribute to the rest of your creditors on your list.

You may also reduce the amount that your paying in financing fees by contacting the creditors and requesting that they lower the interest rate because you’ve been managing them well. At that stage, readjust the creditors on your list. Which creditor gets the bulk of your available cash is often a fluid process.

In the event that any of this sounds like too much work, I urge you to squelch the urge to put it off or not do it entirely. The fact is, not satisfying your bills is not just horrible for your overall financial well-being and the way others perceive you, but it hurts the way you feel about yourself. So consider this your awesome opportunity to do the right thing. You’ll be glad you did. When you gain clarity on who to pay and in the right sequence, you will delete the amount your debts are costing you while offsetting serious repercussions.

Have you ever made a mistake and paid back the wrong debt first? What happened? Share with us below!