In this article:
- When to Consider Paying Off Debt With the Highest Interest First
- When to Consider Paying Off Debt With the Highest Balance First
- How to Choose a Debt Payoff Strategy
When it comes to paying off debt, it usually makes the most sense to prioritize high-interest debt since these balances cost the most money to carry. Paying interest can add up to a huge expense over time—and that's on top of your original debt. So is it better to pay off higher-interest loans first? In some cases, you may want to focus on your largest balance, regardless of the interest rate. The right approach for you will depend on your debt load, rates and financial situation.
When to Consider Paying Off Debt With the Highest Interest First
You should first pay off debt with the highest interest rate if your goal is to save money. This approach is known as the debt avalanche method.
As of the first quarter of 2024, the average annual percentage rate (APR) on credit cards was over 22%, according to the Federal Reserve. Let's say you have a $5,000 balance on a credit card with a 20% interest rate and you make a $150 payment each month. You'll pay an extra $2,359 in interest over the four years it will take you to pay off the card. The faster you eliminate the balance, the more you'll save.
- Start by making a list of all your debts, including their current balances, minimum monthly payments and interest rates.
- Continue making your minimum monthly payments on all your accounts.
- Put any extra money toward the balance with the highest interest rate.
- Once that account is paid off, focus on paying the most to the debt with the next highest rate.
Example of Paying Off Highest-Rate Balances First
Here's what the debt avalanche method looks like in practice. Let's assume you have the following open balances and interest rates:
- A student loan of $4,000 at 7%
- A credit card balance of $3,000 at 20%
- A credit card balance of $6,000 at 18%
- A personal loan of $5,000 at 12%
With the avalanche debt-payoff strategy, you'd prioritize the credit card with the 20% interest rate, even though it has the smallest balance. Let's say the minimum payment on that card is $120 and you pay an extra $80, bringing your monthly payment to $200. When that balance is paid off, you'd move on to the credit card with the 18% interest rate—adding that $200 to your minimum monthly payment.
When to Consider Paying Off Debt With the Highest Balance First
You might consider paying off debt with the highest balance if you plan to apply for a mortgage or other loan in the near future—particularly if your highest balance is on a credit card. Reducing your credit card balances also reduces your credit utilization ratio, which tells lenders how much of your available revolving credit you're using. If your total credit card credit limits add up to $10,000 and your current card debt is $5,000, your credit utilization rate is 50%.
Lower credit utilization can help improve your credit score—and make it easier to qualify for new credit with favorable terms. Paying down high balances may be top of mind if you're hoping to buy a home or use your personal credit to finance a new business.
How to Choose a Debt Payoff Strategy
There are several ways to tackle your debt. Your balances and interest rates will determine the best strategy for you. Below are a few options:
- Debt avalanche: As described above, this approach prioritizes the balance with the highest interest rate, which can help you save money in the long run.
- Paying off the highest balance first: This strategy can reduce your credit utilization rate—and make you a more attractive borrower if you plan on applying for a mortgage or other financing.
- Debt snowball: This tactic focuses on paying off your smallest debt balance first, regardless of the interest rate. The debt snowball might feel less intimidating to implement, and you may enjoy quick wins along the way to stoke your motivation.
- Debt consolidation: This involves taking out a new loan with a lower interest rate to absorb your current balances. Your debt will then be concentrated in one account with one monthly payment. Another option is to use a balance transfer credit card that has a low or 0% introductory interest rate. The goal is to pay off the balance during that period.
The Bottom Line
Is it better to pay off higher-interest loans first? It depends. If your main goal is to save money, then this strategy is worth considering—but your financial situation may inspire you to use another debt repayment method. Prioritizing your highest balance could help you secure new financing with favorable rates and terms. That may come in handy if you're house hunting.
Paying down debt can help improve your credit score, which is no small thing. Free credit monitoring with Experian makes it easy to stay on top of your credit report. If something new pops up on your report, you'll be the first to know.
