If you have multiple loans and credit card balances, it can be difficult to decide whether to pay off the debt with the largest balance or the one with the highest interest rate first.
When deciding the order in which to repay your debts, you should not compare only the amounts borrowed. You also need to consider the outstanding balance, interest rate, minimum payment, due date, past-due status, fees, and whether the debt is secured.
In general, making extra payments toward the debt with the highest interest rate can help reduce your long-term interest costs. Paying off the smallest balance first, however, can eliminate one debt quickly and help you stay motivated to continue your repayment plan.
Whichever method you choose, the basic principle is to make the minimum payment on every debt first and direct any extra money toward one target debt.
What to Check Before Paying Off High-Interest Debt First
A high interest rate does not automatically mean that the debt should be paid before every other obligation.
Falling behind on housing payments, essential services such as electricity and water, taxes, or legal obligations can have serious consequences for your daily life.
If a loan is secured by an asset such as a home or vehicle, failing to repay it may put that asset at risk.
If you already have overdue debt or have fallen behind on essential payments, review your current delinquency status and the possible consequences before beginning a highest-interest-first repayment plan.
If you expect difficulty making a payment, contact your financial institution before the due date to ask whether you can change the payment date, adjust the repayment schedule, or use an available assistance program.
Start by Creating a List of All Your Debts
To determine the correct repayment order, organize all your debts in one place.
Review your loan agreements, card statements, and financial institution apps, and record the following information.
- Financial institution or creditor
- Current outstanding balance
- Applicable interest rate
- Monthly minimum payment
- Payment due date
- Late fees and other charges
- Early repayment fees
- Whether the rate is fixed or variable
- Whether the debt is secured
- Whether the debt is past due
A single credit card may contain balances with different interest rates, such as regular purchases, cash advances, or balance transfers. You should also ask the financial institution how extra payments will be allocated among those balances.
Creating this list may reveal that the debt with the largest balance is not necessarily the one creating the greatest interest burden.
Two Common Debt Repayment Methods
Highest-Interest-Rate Method
The highest-interest-rate method involves making the minimum payment on every debt and then directing all remaining money toward the debt with the highest interest rate.
Once the first debt is paid off, combine its former minimum payment and extra payment and apply the total to the debt with the next-highest interest rate.
The main advantage of this method is that it eliminates the most expensive debt first, which can help reduce your total interest costs.
However, if the highest-interest debt also has a large balance, it may take a long time to pay off. Because progress may not be immediately visible, some people may find it difficult to stay committed to the plan.
Snowball Method
The snowball method involves making extra payments toward the debt with the smallest balance, regardless of its interest rate.
After paying off the smallest debt, add the amount you had been paying on it to the debt with the next-smallest balance.
This method allows you to see the number of debts decrease quickly, which can provide a sense of accomplishment and help maintain motivation.
However, high-interest debt continues to accumulate interest while it remains unpaid, so the snowball method may result in higher total interest costs than the highest-interest-rate method.
Which Repayment Method Should You Choose?
If minimizing your total interest costs is your primary goal, the highest-interest-rate method may be more suitable.
If you have struggled to maintain a debt repayment plan in the past or need quick progress to stay motivated, you may prefer the snowball method.
You can also combine the two approaches. For example, you might eliminate one very small debt first to reduce the number of monthly payments and then repay the remaining debts in order of interest rate.
The important thing is not to choose the method that looks perfect, but to select a repayment strategy you can realistically maintain without giving up.
5 Steps to Eliminate High-Interest Debt
Step 1: Set Aside the Minimum Payment for Every Debt
First, calculate the total minimum payments you must make each month.
Reducing or skipping a minimum payment to make an extra payment on another debt can result in late fees and less favorable repayment terms.
Setting up an automatic transfer to place your minimum payments in a separate account shortly after payday can reduce the risk of missing a due date.
Step 2: Set Aside a Basic Emergency Fund
If you use all your available cash to repay debt, you may have to rely on a credit card or another loan when faced with an unexpected medical expense, vehicle repair, or loss of income.
Before beginning your repayment plan, it is advisable to set aside a basic financial safety buffer appropriate for your circumstances.
how to calculate your emergency fund target based on living expensescan serve as a guide, but you should also consider the interest burden of high-interest debt and the stability of your income when deciding how much to allocate to emergency savings and extra debt payments.
There is no single emergency savings and debt repayment ratio that applies to everyone.
Step 3: Choose One Target Debt
If you choose the highest-interest-rate method, select the debt with the highest interest rate as your first target.
If you choose the snowball method, select the debt with the smallest current balance.
Continue making the minimum payments on all other debts and direct all additional funds toward the selected target debt.
Frequently changing your target can make it difficult to track your progress, so it is best to maintain your chosen order unless interest rates or contract terms change significantly.
Step 4: Decide How Much Extra to Pay Each Month
Review your recent spending records and calculate how much you can use for extra debt payments each month.
How to Separate Fixed and Variable Expensescan help you find money for extra payments by identifying unused subscriptions, overly expensive phone plans, and habitual discretionary spending.
If you cut essential living expenses too severely to increase your payments, the plan may become difficult to maintain. It is more realistic to begin with an amount you can sustain every month and make additional payments when temporary extra income becomes available.
Automatically transferring the extra payment amount to a separate account on payday can reduce the chance that it will be spent elsewhere.
Step 5: Roll the Completed Payment into the Next Debt
Once the target debt is paid off, do not redirect the amount you were paying toward everyday spending.
Combine the previous minimum payment and extra payment and apply the full amount to your next target debt.
As repayment progresses, the amount available for each subsequent debt increases, which can gradually accelerate the overall repayment process.
Whenever you pay off a debt, confirm that the balance is actually zero and that no remaining interest or fees are due.
Example with an Extra Monthly Payment of 200,000 Won
Suppose you have the following three debts.
- Credit Card A: Balance of 1.2 million won, 19% interest rate, minimum payment of 60,000 won
- Loan B: Balance of 4 million won, 11% interest rate, minimum payment of 150,000 won
- Installment Debt C: Balance of 600,000 won, 5% interest rate, minimum payment of 50,000 won
If you can make an additional payment of 200,000 won each month, first pay the combined minimum payments of 260,000 won on all debts.
With the highest-interest-rate method, direct the extra 200,000 won toward Credit Card A. After paying it off, add its former 60,000-won minimum payment and the 200,000-won extra payment to Loan B’s existing minimum payment.
With the snowball method, direct the extra 200,000 won toward Installment Debt C. Once it is paid off, add the 250,000 won you had been paying toward it to Credit Card A, which has the next-smallest balance.
Both methods can reduce your debt, but the estimated total interest and payoff date may differ. Check your financial institution’s actual calculation method and applicable fees.
How to Find Money for Extra Debt Payments
Eliminate Unused Fixed Expenses
Cancel unused subscriptions, memberships, and add-on services, and apply the amount saved as an extra payment on the same date each month.
Set Weekly Limits for Discretionary Spending
Set weekly limits for dining out, food delivery, shopping, and leisure spending, and apply any remaining amount to your target debt.
Decide in Advance How to Use Temporary Income
Decide in advance how much of any irregular income—such as a bonus, refund, or proceeds from selling used items—will go toward debt repayment.
Rather than using all temporary income for debt repayment, also consider upcoming irregular expenses and whether your emergency fund is sufficient.
Reduce New Credit Card Spending
If you continue making new purchases on the same card while repaying an existing balance, the amount owed may not decrease.
During the repayment period, clearly define when you will use a credit card and make only purchases that can be covered within your living-expense budget.
Consider Debt Consolidation Carefully
Combining several debts into one may simplify payment management and could provide a lower interest rate.
However, a lower monthly payment does not necessarily mean a lower total cost. Extending the repayment period may result in paying interest for longer.
When considering debt consolidation, compare the following factors.
- The actual interest rate of the new loan
- Origination fees and early repayment fees
- The total repayment period
- The estimated total interest
- Whether collateral is required
- Whether a variable interest rate applies
- The cost of repaying existing debts early
Converting unsecured debt into a loan secured by your home or vehicle may lower the interest rate, but it can put an important asset at risk if you are unable to repay the loan.
If You Expect Difficulty Making Payments
Do not wait until after the due date. Contact your financial institution or creditor as early as possible.
Ask whether options such as changing the repayment schedule, adjusting the due date, temporarily postponing payments, or arranging installment payments are available.
Changing the repayment terms may reduce your monthly payment, but it may also extend the repayment period and increase total interest. Make sure you receive the revised terms in writing.
When using debt adjustment or debt settlement services, review the fees, contract terms, and potential effects on your credit. Be cautious of companies that demand upfront fees or guarantee that they can eliminate your debt easily.
Frequently Asked QuestionsFrequently Asked Questions
Should I Pay Off the Debt with the Largest Balance First?
Not necessarily.
A debt with a large balance may have a low interest rate, while a smaller debt may carry high interest and fees. Compare not only the balance but also the interest rate, minimum payment, contract terms, and risk of delinquency.
Which Debt Should I Pay First If the Interest Rates Are the Same?
If the interest rates are the same, you may pay off the smallest balance first to reduce the number of monthly payments or prioritize the debt with less favorable fees and contract terms.
Also check for early repayment fees and the expiration date of any promotional interest rate.
Is It Enough to Pay Only the Minimum Amount?
Making the minimum payment can help you avoid delinquency, but the principal may decrease slowly, extending the repayment period and increasing total interest costs.
If you can make extra payments, consistently direct even a small additional amount toward one target debt.
Can I Divide Extra Payments Among Several Debts?
You can, but spreading your extra payments across several debts may make it take longer to eliminate each one.
After making the minimum payment on every debt, concentrating your extra money on one target debt can make your repayment plan easier to manage.
ConclusionConclusion
The order in which you repay debt should not be based solely on the largest balance. It should be determined by comparing interest rates, balances, delinquency risks, and contract terms.
If reducing total interest costs is your priority, begin with the highest-interest debt. If you need quick progress to stay motivated, you may begin with the smallest balance.
Whichever method you choose, continue making every minimum payment, focus extra payments on one target debt, and roll the completed payment into the next debt.
※ This article is intended to provide general financial information. If your situation involves delinquency, secured debt, debt restructuring, or legal obligations, seek advice tailored to your circumstances from your financial institution or a qualified financial or legal professional in your area.
References
Consumer Financial Protection Bureau, How to Reduce Your Debt