Sometimes the hardest part of any task is just getting started. For example, let’s think about the dishes. You see the sink full of them after cooking a meal, and the last thing you probably want to do is actually wash them. But, once you put on some music and start by tossing the utensils in the dishwasher (the simplest of the dishwashing tasks), you feel so much better. You’ve made some progress!
Not to say paying off debt is exactly like doing the dishes…but the hardest parts of paying off debt are deciding to get started, and figuring out where to start.
Whether it’s student loans or credit card debt, we’ve highlighted some things to consider when you’re trying to decide how to pay off your debt. While there is no wrong answer to the question, “Should you start with student loan debt or should you start with credit card debt?” the most important part is to get started. So, let’s get to it.
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Make a list of your debt
Like with the dishes, you have to know where to start with your debt. But, the only way to know where to start is by figuring out how much debt you have. With the dishes, it’s fairly easy to see all of the dishes piled up in the sink and tackle it top to bottom, but with debt it’s not always as easy to see or remember what you owe and to who.
So, let’s start by making a list of your debt. It can be a quick handwritten list on the back of a receipt or a fancy color-coded Excel spreadsheet. It doesn’t matter what it looks like, it just needs to work for you and tell you what you need to know about your debt. Here’s what to include:
- Name of lender
- How much you borrowed (the principal)
- Interest rate
- Term of the loan
- Balance outstanding
- Minimum monthly payment
- Monthly payment due date
Now that you know what you owe, to who, and when it’s due - let’s talk about selecting the strategy for paying down your debts in the way that works best for you.
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3 reasons to pay down credit card debt first
Deciding to pay off credit card debt first over student loan debt is a personal choice based on a variety of factors. Here, we’ve outlined 3 factors that may encourage you to decide to pay down your credit card debt first.
1. Interest rates on your credit cards are high
Between your student loans and your credit cards, your credit cards are more likely to have a higher interest rate. So, what does this mean? Your credit card debt is going to continue to cost you more in the long term.
After you’ve lined up all of your outstanding debt, one option for how to tackle your debt is to sort your debt in order of interest rates, from highest to lowest. By doing this, you are paying off the debt in order of what is going to cost you the most (those with the highest interest rates) over the long term.
2. Paying off smaller credit card balances can reduce total open accounts
If you’ve decided that, interest rates aside, you would rather just knock things off the list based on the size of the balance, that works too. If you line up all of your debt in order of smallest to largest balance, this allows you to pay off the smallest balances first to feel as though you’re making a dent in that list of outstanding balances. Don’t forget, while paying off those smaller balances, it’s still important to make at least the minimum monthly payments on all outstanding debt.
This is often referred to as the “debt snowball method” because once you start knocking off those smaller balances you keep the ball rolling to knock out balance after balance.
Choosing to do this with your credit card debt could allow you to knock out both 1) debt with high interest rates, and 2) individual balances. While this method may be beneficial to your mental health since it allows you to pay off the debt that may be keeping you up at night, if your focus is to spend less money over the long term on interest, this debt snowball method will be more expensive. Paying off smaller balances first could leave larger balances with higher interest rates accruing more interest for a longer period of time.
3. Paying off credit card debt can improve your credit score
Another reason you may decide you want to pay off your outstanding credit card debt is to improve your credit score.
Paying off your credit card’s outstanding balance can help reduce your credit utilization. What do we mean by that? By relying less on the credit you have at your disposal, you reduce your credit utilization percentage (remember, 30% is the magic number), and you demonstrate to lenders that you have a healthy relationship with your credit lines and maintain the ability to pay off your debts as they come due.
On time payments and paying off credit card balances in full every month are great tips to improving your credit score, and choosing to pay off that credit card debt can help give you that credit score boost you need.
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3 reasons to pay down student loan debt first
So, you’ve made your list of total outstanding debt, and now you’re curious about the potential benefits of paying down your student loans first. Let’s explore this option.
1. Interest rates on your student loans are high
Similar to what we explained above about the high interest rates on your credit cards, you may line up your outstanding debt and realize that your student loans have the highest interest rates of your debt.
Who does this typically affect? Students with private student loans (as compared to federal loans) are more likely to have loans with higher interest rates. If this is the case for you, consider tackling those student loans with high interest rates first. By doing this you are paying off the loans that are more likely to cost you more in the future. And the more you consider paying off now, the less you’ll have to pay later!
2. You have private student loans with variable interest rates
On the topic of private student loans (similar to #1 above), you may consider paying off these student loans first. Why? Private loans can have either fixed or variable interest rates, in contrast to federal loans which have fixed rates. Variable interest rates can be seen as riskier because they are subject to changes in the index on which interest rates are calculated This means there is a chance for them to be higher than federal fixed rates at a particular point in time.
Additionally, many private loan providers do not provide loan forgiveness and private loans are often not subsidized. Generally, this can make private student loans seem riskier than federal loans. Therefore, you may consider paying off your student loans first if they are primarily made up of private loans.
3. Your student loans have a small balance
Let’s revisit the idea of the “debt snowball method.” As we previously mentioned, if once you’ve lined up all of your outstanding debt in order of smallest to largest balances, and you’ve determined that your student loans have the smallest balance, you may consider starting your payoff journey here.
If you decide you want to start knocking off those small debt balances one by one, and those student loan balances are at the top of that list, start rolling that snowball. This can be a great starting point to give you some confidence in paying off your debt!
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Time to get started
There is no wrong way to take the first step towards paying off your debt. It’s a personal decision, and once you’ve lined up all of your outstanding balances you’ll be able to decide for yourself how you want to tackle the debt.
Maybe you are focused on not having to pay more in the future. Great! Consider starting with your debt with the highest interest rate (like those private student loans or credit card balances). Or, maybe you have several small outstanding balances that you know you can knock out quickly, and you just want to see those small balances disappear - great, start there!
This blog is not intended to provide any tax, legal, financial planning, insurance, accounting, investment, or any other kind of professional advice or services. To make sure that any information or suggestions in this blog fit your particular circumstances, you should consult with an appropriate tax or legal professional before taking action based on any suggestions or information that we provide.