Dec 2nd, 2007
Paying off debt: prioritizing
I teach parenting classes to folks who are involved with child welfare services and one of the things I tell them is that behavior is on a scale, that some behavior is okay and some is not okay, but there are variations on those. Hitting someone is really not okay; leaving your dirty clothes on the floor isn’t okay either, but it’s better than hitting someone.
Similarly, debt is also on a scale. Some debt is better than others; it depends on what the purpose of the debt was (how much whatever it is that the debt was incurred from was needed) and how expensive the debt is (how much interest is charged and if that interest is tax deductible). Going into credit card debt (typically high interest) to get a new 42 inch HDTV is worse on my debt scale than going into mortgage debt (typically low, tax deductible interest) to buy a house.
Even in some “good” debt, there’s variation. If I go into huge mortgage debt to buy a house I really can’t afford, that’s worse on my debt scale than to go into moderate mortgage debt to buy one I can. If I get an automobile loan to buy a $17000 truck, that’s better than going into automobile loan debt to buy a $30000 truck unless the $30000 truck has some feature I really need and can’t otherwise fill with $13000.
When taking a look at your debt and considering where to best put your resources to pay them off, I suggest ranking them in order depending on the factors above. For me, unsecured consumer debt (typically credit card debt) would likely be the first to try to pay off–the higher the interest rate, the higher the priority. An automobile loan may be in the middle (again, depending largely on the interest rate) and the bigger ones with lower rates and tax deductibility–that would be student loans and a mortgage on my primary residence–would be last.
There are other approaches to deciding which bills to pay first and which to wait on, including the snowball method I first learned of in Financial Peace; we’ll look at that approach in a future blog post.
How do you decide which debt to pay off first?
