Which Debt Should You Pay Off First: Lowest Balance Or Highest Interest?

Posted by: KHTS Articles in News Articles July 12, 2021 - 8:31 am 0 963 Views

If you’re managing multiple debts, you may be struggling with where to start your repayment journey. When developing a debt paydown strategy, it’s common to start with either your lowest-balance debt or highest-interest debt. And while tackling the highest-interest debt might save you more money, starting with the lowest balance can seriously increase motivation.

So, here’s what you need to know to create an optimal strategy for which debt you should pay off first.

Benefits of paying your lowest-balance debt first

The repayment strategy that starts by paying off the lowest balance is sometimes referred to as the debt snowball method. By crossing a smaller debt off your “to pay” list, you’ll get a quick win. And this quick win can increase motivation as you progress to paying toward your higher balance debts.

After you pay off the first debt, you’ll apply that payment to the second debt. This puts more money toward each subsequent debt, creating the effect of a snowball rolling down a hill and gathering momentum.

Benefits of paying your highest-interest debt first

Starting with paying on your highest-interest debt is sometimes referred to as the debt avalanche method. This strategy typically results in more significant interest savings by eliminating higher-interest debts first. However, with this method, you may not see the same quick win you’d get by taking out the lowest balance first.

As with the debt snowball strategy, upon completing your first debt payoff, you’ll put any extra money toward your second highest-interest debt. You’ll then continue until all debts are paid, hopefully saving loads of money in interest along the way.

How to choose a debt paydown strategy

Depending on how much debt you have, repayment may take months or years. That means choosing the best strategy is critical to keeping you on track for the long term. Here are some tips to help decide which debt to pay off first.

Organize your debt details

Start by capturing the specifics of your loans and credit cards. Create a list that outlines your terms, the current balance due, and the interest rate. By putting all of these debt details together, you’ll be able to figure out the best place to start.

Calculate potential savings

Next, use a debt payoff calculator to compare how much you can save by paying down the lowest balance vs. highest interest first. You may realize that there are profound financial implications to paying off the highest-interest debt first. And if you’re driven by cost savings, that might make your decision simple.

For example, let’s say you have two debts: a credit card with a $5,000 balance at 16% APR and a car loan with a $3,500 balance at 4.5% APR. We’ll also assume you’re currently paying $100/month on each and can afford another $50 toward debt repayment. By starting with the highest-interest debt, you could end up saving around $300 more than if you started with the lowest balance.

Choose which debt to pay off first

You know yourself and your financial situation best. That means you’re the only person who can say whether it’s best to start with the lowest balance or highest interest. If you’re motivated by saving money, tackling the highest interest debt with the avalanche method probably makes sense. But if you’re motivated by small wins, it’s likely best to begin with the lowest balance and use the snowball strategy.

The bottom line

Whether you choose the debt snowball, debt avalanche, or another debt repayment method, what matters most is that you’re consistent. By making regular payments and sticking to your strategy, you’ll pay off the debt in less time and ultimately pay less money in interest.

Brooke Joly

Brooke is a freelancer who focuses on the financial wellness and technology sectors. She has a passion for all things wellness and spends her days cooking up healthy recipes, running, and snuggling up with a good book and her fur babies.