If you are looking to eliminate your debt by making payments towards various types of debt like credit cards, auto loans, student loans, cash advance loans, or any others, a good strategy to follow is to try to contribute to your highest interest rate debts first. Prioritizing higher interest rates can help you relieve all of your debts faster than if you were to contribute equal amounts across the board.
We can take an example to illustrate a situation. Let’s consider 3 different types of credit card debt. Credit card #1 has a balance of $10,000 at an annual interest rate of 10%. Credit card #2 has a debt of $10,000 at an annual interest rate of 3%. The last one, credit card $3, has a debt of $10,000 at an annual interest rate of 20%. Each of these cards has a minimum payment percentage of 3% and a minimum payment amount of $25.
So, here are the debts:
#1: $10,000 @ 10%
#2: $10,000 @ 3%
#3: $10,000 @ 20%
Here is how much interest you would pay if you were to make minimum payments on each until the debt is paid off:
#1: $3,672.64 in 12.8 years
#2: $871.20 in 10.3 years
#3: $11,851.51 in 19.6 years
With the same amount of debt, it costs significantly more and will take much longer to keep a higher rate interest debt rather than a lower rate interest debt with the same amount of debt. If you have any extra income to help pay off debt, it would be best to allocate the extra income to the highest interest rate in #3 to limit your exposure to that interest rate. It will save you more money to pay off #3 first rather than #1 or #2. The next in priority would be to pay off #1, and then you can pay more to #2.
You should keep continuing to make minimum payments on all cards so that you don’t rack up past due payments or penalties. Past due payments and penalties can also cause some creditors to raise your interest rate sending you into a downward spiral of higher interest. But if you had to choose which card to contribute more towards, pay the higher interest debts first so that the potential in interest payments can be made as small as possible.
