What to Pay Off First: An Advisor’s Take

The median credit card debt in American households is currently $2,300, and many families have various other types of debt, in addition to credit card debt. According to NerdWallet, the average family owes $178,037 on their mortgage, $27,755 in auto loans, and $47,047 in student loans.

It’s one thing to deal with debt when you have just one type of loan, or are only carrying a balance on a single credit card. It gets even more overwhelming, stressful, and confusing when you have multiple loans or balances to repay at the same time.

You need a strategy for debt repayment when dealing with more than just a single balance or loan. Here's how to determine what to tackle first when you have multiple types of debt:

Organize Your Debt and the Money You Owe

Before you can accurately determine what debt to pay off first, you need to complete a full inventory of everything that you owe.

This can be a scary step if you have a lot of debt, but it’s necessary. You can’t repay your debts in a strategic fashion and achieve a better financial position if you are not informed about your financial situation.

First, make a list of everything you owe: list the balance or loan amount (what’s left to pay), the minimum monthly payment you owe on each debt, and the interest rate.

Next, you’ll want to put your list in order of priority. There are two ways you can do this:

  1. List by the highest interest rate to the lowest interest rate
  2. List by the lowest balance to the highest balance owed

What is the “right” way to pay off your debt? It depends on how you feel about your debt. Mathematically speaking, the best way to pay off your debt is to tackle the debt with the highest interest rates first because it will end up costing you the most money in the long term: the sooner you pay it off, the more you’ll save.

For some people, debt isn’t just a financial issue. It’s also an emotional issue. If you repay your debt with the lowest balance first, you will have the relief of having completely payed off one of your balances. This feeling can motivate you to keep going paying down your debt. 

It will cost you more if you hang onto higher-interest rate debt, but if quickly paying off small balances keeps you motivated, it might be a better strategy in the long run (and certainly better than getting burned out, frustrated, and overwhelmed to the point that you stop taking action, which can happen if you tackle a debt with a big balance that takes a long time to repay).

How to Pay Off Your Debt Strategically

Let’s look at an example of how you might make a list of your debts if you have the following balances:

If you want to put yourself in the best financial spot possible, you should pay off "Credit Card A" first because it’s the debt with the highest interest rate and it costs you the most money.

Just because that’s the debt you pay off first, doesn’t mean you should stop making payments on the rest of your debts. You need to make at least the minimum payment on all of your loans so that you don't default.

Here’s how you could strategically repay all of this debt in the most financially efficient way possible:

  1. Pay off "Credit Card A" with the 19% interest rate. Make minimum payments on all your other debts.
  2. Pay off "Credit Card B," with the 15% interest rate. Continue making minimum payments on all your other debts.
  3. Pay off the car loan. You’ll want to take whatever monthly payments you made on your credit cards and apply those to your car loan balance, so you’re paying more than the minimum payment on that loan. Continue making minimum payments on the other loans.
  4. Once the car loan is repaid, take the total amount you contributed to that balance on a monthly basis (the money you put toward credit cards, plus the monthly payment on the car loan), and add that to the monthly payment you were making on your student loan. Pay that until the student loan is repaid, while continuing to pay the monthly minimum on your mortgage.

At this point, the only debt you’ll have left will be your mortgage. Now, the question becomes not what to pay off first – rather, how much should you pay on your mortgage and how much should you be investing?

Should You Pay Off Your Mortgage, Too?

Mortgages usually come with lower interest rates (relative to other types of debts) and are considered good debt, since your payments go toward building equity in your home. Also, the interest that you pay on your mortgage may be tax deductible.

In this situation, the important question is whether or not it's financially wise to be debt-free sooner, including your mortgage, or increase your wealth by investing that money instead?

While you can’t predict how any investment will perform in the future, the average return of the S&P 500 over the past 70 years, including dividends being reinvested, was 9.73%. If your mortgage interest rate is 3%, 4%, or even 5%, and your investment time horizon is 10 years or more, investing (versus making additional principal payments on your mortgage) may make sense.

It's important to note that the average rates of return on investments can be deceiving. The stock market can have negative or flat returns for an extended period of time, so your investment time frame and risk tolerance are important considerations.

Make a Plan For Your Debt Repayment

It's easy to avoid thinking about your debt when it feels like there's no way you can pay it all off. However, being able to differentiate between the kinds of debt you have, and then prioritizing what needs to be paid off first, is the first step in being able to mentally approach it. Once you can comprehend the extent of your debt (even if the total amount you own isn't a lot), you can create a tangible plan for how to manage, and then pay off, all of your loans and balances. 

Disclosure: Securities offered through Triad Advisors, LLC, Member FINRA/SIPC; Advisory Services offered through AspenCross Wealth Management, Inc. a Registered Investment Advisor. AspenCross Wealth Management is independent of Triad Advisors, LLC.