Debt Prioritization

How to strategically manage how your debts get paid.

First and foremost, debt prioritization should never be considered a strategy for which debts get paid, it’s a strategy how your debts get paid. The instructions below are designed to help you strategically manage your debt payments so you can minimize interest charges and maintain control of your budget.

If you’re really having trouble managing your debt, your best strategy is to act immediately to find a solution. If you don’t know the full range of options you have available for debt relief, talk to a credit counsellor. Call us at 1-844-402-3073 for a consultation free of charge.

Debt prioritzation should be ranked by interest rate

Debts that have higher interest rates cost more money, every dollar of debt owed costs more each month it’s allowed to carry over without being paid. So priority in your budget should always be given to the debts with the highest interest rate.

Again, this doesn’t mean you don’t pay your mortgage and car loan first – in this strategy, you’re paying all of your debts on time every month. However, extra money in your budget that you allocate for debt elimination should be focused first on the debts that cost you the most.

This usually means things like high-interest store cards and reward credit cards should always be paid off in-full within one payment cycle. Lower interest credit cards are usually next. Then once you eliminate high interest revolving debt, you can focus cash for debt elimination on your loans.

So within in a good debt prioritization strategy, you always pay off debt starting with the largest interest rate first. Any debt that has to be carried over should be on credit lines with your lowest interest rates –or ideally, a credit line with no interest at all.

Just be careful, because introductory interest rate periods are often where people get into trouble. Keep careful track of the introductory period and make sure to divide your balance up by the number of months you have left so it can be paid off before interest gets applied. Otherwise, you can have a balance of a few thousand dollars that’s suddenly getting hit with an interest rate that can be over twenty percent.

Always read loan terms carefully before making extra payments

Once you have your credit cards paid off and are paying the balances off every month, it’s usually time to move onto loans. Just make sure to read terms carefully to see what happens if you make extra payments or larger payments. In some rare cases, some loans can actually penalize you for early repayment, so make sure that’s not an issue.

You also need to be aware that making extra payments on loans usually will not change your payments; it simply reduces the number of months you’ll need to repay the loan. That’s good, because fewer months of paying means less months to pay interest, but just be aware that it doesn’t change your budget.

The one loan that may adjust your payment schedule for paying off a certain amount is a mortgage. However, you have to pay off a significant amount of money in order to pay off “points”on a mortgage. If you pay enough –usually about 1% of the total original loan amount –you may reduce your mortgage interest by one eighth of a point. If you do so, it can change the amortization table on your mortgage, which may change your payment schedule.

You should review your lending terms carefully and talk to a qualified professional before making extra payments on your mortgage. So even though you can change the payment schedule on a mortgage, it’s usually a better idea to prioritize loans like student loans and your car loan first.

Don’t be afraid to consolidate

Debt consolidation is a practice where you combine multiple debts of the same type into a single monthly payment with the lowest interest rate possible. Consolidation allows you to simplify your bill calendar by rolling multiple debts into one payment. It can also help you avoid problems with high interest.

With that in mind, don’t be afraid to consolidate debt if you have several debts of the same type. Of course, you can consolidate debt from credit cards in a number of ways, but you also have options for student loan consolidation. By consolidating your debts, you can pay off everything at once without dividing your attention and having a range of bills on your plate to cover at the same time.

Debt elimination shouldn’t use all of your extra cash

One mistake people often make is that they prioritize ALL debt elimination before other important things in their budget, such as savings. Making extra payments on debt is good because it allows you to avoid financial distress caused by debt and save money on interest. However, you shouldn’t focus your entire financial attention on paying off debt to the detriment of things like establishing a healthy saving strategy.

In a balanced financial strategy, both debt elimination and savings can occur at the same time. You should allocate some of your extra cash flow towards debt elimination, but some of it should go to savings as well.

And if you have to choose between the two, have a good reason for doing so. For instance, if your debt levels get too high and your debt-to-income ratio is out of balance, then you may want to allocate more money towards debt elimination until you can reestablish a stable outlook. On the other hand, if you’ve eliminated every debt except your mortgage and you have an investment opportunity that that earn more money than you spend on the interest accrued on your mortgage, it may be worth it to focus on getting that investment set up before you work towards paying off your mortgage in-full.