Personal Finances: Prioritizing and Paying off Debt

When the calendar says it's the first of the month, do you get excited about the opportunities that may arrive with the new month, or do you have panic attacks on how you are going to survive another month living in debt

If it's the latter, read on. We'll share tips on how you should prioritize debts to get your personal finances in the best shape possible.

Pay Down Your Debts

There are two key successful methods for paying off debt and getting your personal finances in order:

1. Start With Your Lowest Balance First

First, review your debt – all of it! This includes credit cards, medical bills, and student loans. Organize your debt from the lowest to highest balance. Start with your lowest balance debt first, disregarding the interest rate. Once the lowest balance debt is paid, select the second-lowest balance debt, and so on until all your debt is paid off. 

Financial experts call this the “snowball method.” According to research, people struggling with debt have made significant strides in eliminating their debt using this method. Paying off your smaller debts is more achievable and inspires you to keep paying off the rest of your debt. Small successes can equal big payoffs on the road to becoming debt-free.

2. Pay The Highest Interest Rate First

With this method, you will organize your debts from highest to lowest interest rates and concentrate on paying off the highest interest rate debt first. When that debt is paid off, tackle the second-highest interest rate debt, and so on. 

What's the purpose of this method? By paying off the highest interest rate debt, you help keep the debt from ballooning into the stratosphere to where it becomes harder to pay off the debt. Also, paying off the high-interest debt first keeps you from owing more overall on the debt. If you pay off the highest interest debts first, you reduce the total amount that you will owe on your way to becoming debt-free. From a total debt owed standpoint, this method is the most logical.

Caveat: If you continue to add to your debt while trying to pay it off, your efforts will be futile. Your first goal is to stop adding debt to the pile!

Which Debt is a High Priority?

If you are beyond the point of no return with managing your debt, the two methods above will not be enough. In fact, these methods may not be doable at all. Instead, here's what you need to do immediately – start with your high priority expenses first. These are:

1. Food and Medicine

Are you familiar with Maslow's Hierarchy of Needs? The ability to take care of your basic needs matters first, above all else in personal finances. These expenses are at the top of the list. So please earmark your income to buy food for you and your family. This also applies if you take medicine or need medical care (the type that requires pre-payment). This doesn't include medical bills. 

2. Mortgage or Rent

You need to live somewhere practical, where you can keep paying your mortgage or rent payments. Real estate taxes and homeowner's insurance falls within this priority if it's not already included in the mortgage. Likewise, homeowner association fees should be deemed a high priority. If you don't pay these expenses, you could lose your house and/or have a lien put on your mortgage.  

3. Utilities: Electricity, Oil, Gas, Water

Pay your utility bills, even if it's the minimum payment to avoid disconnection. You should call the utility companies to see if they offer budget billing or if you qualify for hardship assistance. You don't want to be left in the cold or the dark.

4. Auto Loans/Lease and Insurance

Pay these expenses if you live in the suburbs or country and need a car to get to work. Make sure you stay current with your insurance payments. If not, the creditor could purchase expensive insurance at your expense that may give you less protection. Also, in most states, it's illegal not to have auto liability coverage.

5. Income Tax

In a letter, Benjamin Franklin wrote, “In this world, nothing can be said to be certain, except death and taxes.” Regardless of your debt situation, you must pay any income taxes you owe. This includes filing a federal income tax return, even if you are unable to pay any tax due.

6. Child Support Payments

If you are obligated to pay child support, this debt is a must-pay. If you don't pay it, your wages could be garnished, and you may even get prison time for non-payment. We're certain you don't want that to happen!

Which Debt is a Low Priority?

The following debt is considered a lower priority when you are in debt up to your eyeballs.

Credit Cards and Medical Bills

Debt considered low priority is credit borrowed without collateral. This includes credit card debts and medical (doctor/hospital) bills. These types of debt don't require collateral, such as a house or car, to acquire these loans and are considered unsecured debt. 

Tip! Creditors have little recourse in the short term if you don't pay your bill. Consider credit counseling, debt consolidation, or even debt settlement. 

Loans with only Household Items as Collateral

This type of debt is also a low priority, as they are unlikely to affect your personal finances significantly. A creditor may ask you to use some of your household items as insurance on a loan. However, you should consider this loan the same as unsecured debt. The odds of a creditor taking your household items in exchange for monetary compensation are rare. Most household items have little resell value, and creditors would need to obtain a court order to seize them. Their time is not worth the expense.

Tip! Don't feel threatened by a debt collector even if they inform you that they will sue in court. Your collateral may even be exempt from seizure. Discuss your options with a debt relief provider. 

What About Student Loans?

Student loans are in a league of their own and can ruin your personal finances if you're not careful. They are not tied to collateral but cannot be discharged if you file for bankruptcy. Aside from student loan forgiveness, you must pay them. Student loans fall into two camps:

Government Student Loans

Government student loans should be paid before your low-priority debts. Since you acquired these loans with government funding, the law allows the government to pursue collection from you. These collection efforts include paycheck garnishment, tax refunds and liens, and reduction in Social Security benefits. You don't want to go there. You work hard for your money.

Tip! You may qualify for income-based student loan repayments, deferment, refinancing, and loan consolidation. You may be able to get the debt canceled in a few situations. Contact your loan provider for more information.

Private Student Loans

Private student loans are like other types of unsecured debt and should be paid after your high priority debt and your government student loans, but before your low priority debt.

Tip: Refinance your student loan debt to reduce your monthly payment and interest owed. 

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