Which debt should you pay off first?

Covid-19 changed the way South African consumers pay their debt. According to a new TransUnion Global Payment Hierarchy study our payment behaviour changed to prioritise paying credit card debt rather than personal loans. Lockdowns forced people to make more online payments using credit cards, which means the focus at the end of the month changed from paying off personal loans to paying off credit card debt. This begs the question: which debt should you pay off first?

The best way to pay off debt isn’t the same for everyone. In fact, the debt you should pay off first depends on your income, expenses, and other obligations, such as being financially responsible for children or aging parents. Whether you’ve got a mountain of debt or just a few credit card balances you’d like to pay off, how and when you tackle your debt depends on your individual circumstances. Here’s how to determine which debt to pay off first.

Debt by Type

While all debt boils down to the money you owe, there are a few different types of debt. For instance, installment credit are lump-sum loans that you borrow and then repay in monthly installments over a few months or years. Revolving debt is usually an available balance you can borrow from rather than taking a lump-sum payment. Instead of borrowing once and making payments as with installment credit, you can borrow at any time.

Installment credit includes:

  • Home loans
  • Vehicle loans
  • Student loans
  • Personal loans
    Revolving debt includes:
    • Credit cards
    • Home equity lines of credit
    • Personal lines of credit

      There are also two kinds of debt: secured debt and unsecured debt. Secured debt is backed by collateral (for example a house or vehicle) while unsecured isn’t. If you fall behind on payments to a secured debt—like a loan or car loan—that collateral could be repossessed by your creditor.

      Whether your debt is secured or unsecured is important because it could impact which debt you pay off first. For instance, if you just bought a home—one of the biggest purchases of your life—you probably will not be financially able to pay off your home loan right away. However, if you recently graduated from university and are only making minimum payments on your student loan, you may want to consider making larger payments in order to pay off that debt sooner. Also, it’s wise to pay off secured loans first so you don’t run the risk of losing your collateral. Missing a few payments on your credit card will impact your credit score negatively. Missing a few payments on your home loan means you could lose your house or vehicle.

      Debt by Interest Rate

      The interest rates you are paying may also determine which debt to pay off first. For example, a credit card with a high interest rate will take a long time to pay off since interest makes up a big chunk of your minimum payments each month.

      If you want to tackle high-interest credit card debt, you could use the “debt avalanche” method. With this strategy, you’ll pay off the loan with the highest interest first while continuing to make minimum payments on your other debt. Once your highest-interest debt is paid in full, put the extra money you used for the paid-off debt toward the card with the second-highest interest rate. Continue this process until all your debt is paid off.

      The debt avalanche method is a good strategy for people who want to pay off high-interest debt as soon as possible, even if you won’t see results immediately.

      Interest rates are just one factor to consider when deciding which debt to pay off first. It may make more sense to pay off your smallest balances first to build momentum or pay off an overdue balance that might go into debt collections soon.

      Debt by Balances and Terms

      While the debt avalanche method might save you more money, you may be better off using the “debt snowball” method. Rather than focusing on interest rates, you pay off your smallest debt first while making minimum payments on your other debt. Once you pay off the smallest debt, use that cash to make larger payments on the next smallest debt. Continue until all your debt is paid off.

      The debt snowball method is a good strategy if you respond well to little victories and don’t have the patience to tackle big balances first.

      If you have a small debt, like a few thousand Rands, you might be able to pay this off in a few weeks or a couple of months. This first win may be the motivation you need to stay the course and pay off your remaining debt.

      Debt by Emotional and Financial Stress

      Sometimes the debt you pay off first has nothing to do with interest rates or tax breaks. Instead, it could be solely based on how the debt makes you feel.

      For instance, if you borrowed money from a friend or family member, you might feel a strong obligation to pay off that debt first, even if there’s no interest tied to it. If you have outstanding medical debt, that may get your attention over other types of debt.

      Payday loans, which require payment by your next payday and tend to charge exorbitant interest rates and fees, might be taking a toll on your emotional health. In that case, try to pay off those loans as soon as possible.

      When to Ask for Help

      When you have become overwhelmed by debt and creditors are threatening to reposes your assets or take legal action, it might be too late to try any of the above techniques. Debt Counselling may be the only way to secure your assets by guaranteeing legal protection from your creditors. Speak to one of our qualified debt counsellors. Email hello@debtcare.co.za or call 0861 997 873.

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