Which Debt to Pay Off First

Created by FindLaw's team of attorney writers and editors.

Congratulations! The decision to pay down your debt is a great first step toward getting your finances under control. However, it's important to prioritize which debts you pay first. Debts often grow at different rates and have different consequences for default. Throwing your limited cash at the wrong debt can put you in deeper debt than when you started due to the interest and penalties that may accrue on your other loans. Below, you'll find information to help you prioritize your debts.

First, Pay for the Necessities

Many borrowers have fallen behind on their mortgage payments, car loans, or utility payments. If you miss too many of these payments, the creditors can foreclose on your house, repossess your cars, or shut off your utilities. However, most of these loans have lower interest rates than other types of consumer debt, such as credit cards. This means that your debt load on these loans will grow at a slower rate than that of your credit card debt.

As a result, many bankruptcy and consumer debt attorneys advise borrowers to make the minimum payments necessary to keep their house, their car, and their utilities on while they work on other debts. Borrowers can often negotiate with banks to work out a new payment schedule or reduce the total amount of the loan. Of course, if you are current on these debts, or have already worked out an alternate payment schedule, it's best to stay on course.

Borrowers who are far behind on their secured debts sometimes find that lenders will choose not to apply their payments to their debt. If you think this is happening to you, you should speak with an attorney right away. You may also want to consider setting up a separate savings account to keep your payments in until you are sure they will be applied correctly.

Second, Fulfill Your Legal Obligations

Child support and tax payments are serious obligations that are rarely discharged in bankruptcy. Fortunately, most child support and tax collection agencies are willing to work with a debtor to create a payment plan that fits the debtor's budget. If you have a payment plan worked out, be sure to follow it exactly. Failure to make tax or child support payments can have devastating consequences, including raised interest rates, wage garnishment, or even jail time.

Third, Pay off Your Debts, Starting with the Highest Interest Rate

Now that you've made sure you can stay in your house and taken care of your legal obligations, you can work on paying down the rest of your debt. For many consumers, the largest part of their debt burden is made up of credit card debt. This type of debt typically carries an interest rate between 20 and 30 percent. As a result, the majority of credit card debt is often made up of late fees and accrued interest, rather than the cash actually borrowed. Thus, the banks that issued the credit cards can often reduce your credit card debt significantly and still avoid suffering any actual loss. In such cases, they typically require you to make a lump sum payment. Agreeing to this reduction may have tax consequences.

If you don't have the cash on hand to make these lump sum payments, simply pick the loan or credit card with the highest interest rate and put as much money as you can toward that debt. Once that debt is paid off, cancel the card and move on to the loan with the next highest interest rate. You may also consider consolidating your loans. That involves taking out yet another loan, using it to pay off your existing debt, and then paying the consolidation loan off over time. Many borrowers prefer this option, since it's often easy to find a loan with a better overall interest rate. In addition, having to keep track of only one loan instead of several is a relief for many debtors.

Fourth, Pay Your Deferred Loans

Finally, most student loans allow you to defer payments if you are in difficult financial times. The loan will still accrue interest while in deferral, but usually the interest rate is lower than those of other types of debts. Once the rest of your debt is under control, and you have a steady income, you can resume payments on your deferred loans.

Finally, Know When to Ask for Help

Repaying debt is a difficult and draining task for many borrowers. Debt counselors and debt reduction programs are available to help. Unfortunately, however, the field is rife with scammers.

For more information, see FindLaw's sections on Using a Bankruptcy Attorney or Bankruptcy Basics.

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