Debt is a common problem that most people face in their lives. The thought of paying off debt can be overwhelming, and it’s not always easy to know where to start. One question that many people ask is whether they should focus on paying off high-interest debt first or pay down principal balances with lower interest rates first.
Firstly, it’s important to understand the difference between high-interest debt and low-interest rate debt. High-interest debt includes credit card balances, personal loans, and payday loans. These types of debts usually have double-digit interest rates which means you end up paying back much more than what you originally borrowed.
On the other hand, low-interest rate debt includes mortgages, car loans, and student loans. These types of debts typically have lower interest rates than high-interest debts making them more affordable over time.
When deciding whether to pay off high-interest debt or low-interest rate debt first, there are a few factors to consider:
1. Interest Rates
As mentioned above, high-interest debts come with higher interest rates compared to low-interest rate debts. Therefore if you only make minimum payments on your credit cards each month instead of paying extra funds towards them as soon as possible then each month your balance will continue accruing interest at an astronomical pace until eventually reaching its limit leaving little left over for anything else when bills come due at the end of every statement cycle while making no headway in reducing this burden whatsoever; however if focusing solely on paying down larger principle balances associated with lower-rate loans such as those tied up in auto-financing agreements or home mortgages then less money overall goes towards servicing these obligations over time since they accrue less per annum leading into greater long-term savings opportunities down-the-line which may prove beneficial depending upon one’s individual financial situation.
2. Debt Size
The size of your outstanding balances also plays a role in determining which type of debt to pay off first. If you have multiple smaller high-interest debts, it may be better to focus on paying these off first as they can quickly accumulate and become unmanageable. On the other hand, if you have a large low-interest rate debt such as a mortgage or car loan, it’s best to focus on paying down principal balances.
3. Personal Preferences
Your personal preferences will also play a role in deciding which type of debt to pay off first. Some people prefer the psychological satisfaction of paying off smaller debts first while others prefer to focus on larger debts with lower interest rates.
In general, it is recommended that individuals prioritize high-interest debt before focusing on low-interest rate debt. This is because high-interest debts can quickly spiral out of control and become unmanageable over time due to the compounding nature of interest rates. By paying off high-interest debts first, individuals can save money in interest payments over time and reduce their overall debt burden.
However, there are some exceptions to this rule. For example, if an individual has a very large low-interest rate debt such as a mortgage or car loan that makes up the majority of their outstanding balances then focusing solely upon reducing principle amounts associated with these loans could prove more beneficial long-term instead since less money overall goes towards servicing them each year compared against higher-rate obligations like credit card balances or personal loans which accrue more per annum leading into greater eventual savings opportunities down-the-line due simply by making regular monthly payments over time without any additional effort required outside basic budgeting measures.
Additionally, individuals should consider their own financial situation when deciding whether to pay off high-interest debt or low-interest rate debt first. If an individual has limited funds available each month for repayment purposes then prioritizing higher-rate obligations may be necessary in order to avoid falling behind while simultaneously building up savings reserves elsewhere like retirement accounts where possible depending upon one’s age group & risk tolerance levels among other factors considered pertinent based upon individual circumstances.
In conclusion, when deciding whether to pay off high-interest debt or low-interest rate debt first, individuals should consider a range of factors including interest rates, debt size, and personal preferences. While it is generally recommended that individuals prioritize high-interest debts before focusing on low-interest rate debts, there are some exceptions depending on individual financial situations. Regardless of which approach an individual takes, the most important thing is to create a plan and stick to it in order to achieve financial freedom and reduce overall debt burdens over time.