Know Which Loan You Should Pay Off First

Debt can pile up, even if you stick to your budget. Maybe there was an emergency and you needed a credit card to cover the expenses, or you’ve recently graduated and are beginning to repay your student loans. With monthly interest rate charges, and balances that don’t seem to be getting smaller, your debt could make you feel like you’re stuck.

It doesn’t have to be that way, though. Getting out of debt all starts with figuring out which loan you need to pay off first. In this article, you can learn how to determine which loan is your first priority, and find out about some of the more popular repayment methods.

Throwing money at a large balance until it gets smaller may whittle down your debt eventually, but there are more strategic ways of paying off your debt that could get you to the finish line sooner.

The trick is knowing which loan to pay off first.

When it comes to debt, two of the most important factors are your interest rate and balance total. Your interest rate is a percentage that you pay that represents the cost of borrowing the loan – the higher the percentage, the more you pay. Your interest rate will depend largely on your credit score when applying for the loan.

Your balance is the total amount of money that still needs to be repaid on a loan. When you make a monthly payment, some of that payment goes toward interest, and the rest toward the balance.

If you have multiple debts with varying interest rates and balances, those factors can help you decide which loans to tackle first.

Below are two of the most popular methods for paying off debt.

1. Pay High-Interest Loans Off First

Ignoring interest rates can be a big mistake when paying off debt. High-interest debt can cost you more the longer you have it, so it makes perfect sense to pay off the loan with the highest interest rate first. The nickname for this tactic is the “avalanche method.”

When utilizing the avalanche method, put your largest payments toward the loan with the highest interest, while making the minimum payments to your other debts. This way, you can chip away at the high-interest loan while still keeping up on your other payments. Once the high-interest loan is paid off, direct your larger payments to the loan with the second highest interest rate, and so on until you’ve paid them all off.

One downside to this method is that, if your high-interest loan has a large balance, it could be a long time before you start seeing results. If you want to see the fruits of your labor sooner, you may prefer the method below.

2. Pay Your Smaller Loans Off First

Often called the “snowball method,” the act of paying off your smaller loans first can help you feel some real progress in your debt repayment. Look at the balances of each of your debts. Focus your larger payments on the one with the lowest balance. Once that’s paid off, direct your payments toward the second smallest loan.

Some have found “snowballing” their debts to be the more satisfying method, but the key to success is to keep applying the same amount to the next loan after knocking one out. Eventually you’ll just have the one large debt to face.

3. Adopt A Balanced Method

You can also strike a balance between the two methods by ranking your debts in order of highest interest rates. If two or more of them have the same or similar rates, try and pay off the one with the smaller balance first. This way you can save on interest, while also enjoying an immediate win by taking that loan out of the picture.

The snowball and avalanche methods can both be applied to federal and private student loans as well, and the decision is ultimately up to the one repaying the loan. Many may find, though, that focusing first on any private student loans may save them money in the long run.

Private loans tend to have higher interest rates than federal student loans, and may have more limited repayment options or opportunities for loan forgiveness. As with the avalanche and snowball methods, make your minimum payments to your federal loans while putting additional cash toward your private loans until they’re completely paid off. You can then polish off your federal student loans however you see fit.

Is it better to pay off small loans first?

As mentioned above, some may prefer the snowball method of paying off smaller loans first, as it can more quickly show you the results of your repayment strategy. Ultimately, though, your higher interest loans will cost you money every month they go unpaid. A combination method may be ideal if you have multiple loans with similar interest rates.

Is it better to pay off subsidized or unsubsidized student loans first?

The U.S. Department of Education offers subsidized loans to undergraduate students who have a proven financial need. These loans are interest-free for the student while they’re enrolled in their college or university, and for the first 6 months after they leave. Additionally, students won’t owe interest on a subsidized loan during deferment periods.

Unsubsidized loans are available to undergraduate and graduate students, whether they can demonstrate a financial need or not. Unlike subsidized loans, they charge interest while students are enrolled, during grace periods and deferment periods. Students and families who cannot demonstrate their financial need may opt for unsubsidized loans, as well as students wanting to attend graduate school.

The U.S. Department of Education offers both subsidized and unsubsidized loans to qualifying students with financial needs. The differences between these two types of loans play a role in knowing which loan you’ll want to pay off first.

Since unsubsidized loans charge interest regardless of your situation and accrue more quickly over time, it makes sense to target those first, particularly the loans with the highest interest rates. Follow up by paying off any subsidized loans with high interest rates.

Once your higher interest loans are paid off, you should again target your remaining unsubsidized loans first, followed by your lower interest subsidized loans.

Is it better to pay off a loan early?

If you're financially able to, and your loan has no prepayment penalty, then it could be worth your while to pay off your loan as early as possible. You could save money by paying off higher interest loans and enjoy having one less monthly payment in your life.

Before you throw all your money at your loans, though, consider your budget. Can you afford to make those additional payments per month? Do you have other debts that you still need to pay? If you don’t have any savings stored away, it might benefit you more to put that extra money toward building an emergency fund.

Not everyone may have the time or means to attack their debt head on with the snowball or avalanche method.

Consider these alternative strategies for managing your debt:

Refinance Your Loan

Some loans will allow you to refinance them for a lower interest rate and monthly payment. This can be especially helpful for students with their federal or private loans. Speak to your lender about your refinancing options – you could save yourself some time and money.

Consolidate Your Debt

For many borrowers, keeping track of multiple loans is a major part of the struggle. This is why some opt for debt consolidation to turn their multiple debts into a single monthly payment.

Common forms of debt consolidation include the following:

• Home equity loan. A home equity loan allows you to borrow money against the equity you’ve built into your home. A major risk with this type of loan is that your home is used as collateral, meaning you could lose it through the foreclosure process if you fail to pay off your debt.
• Home equity line of credit. Often abbreviated as HELOC, this is similar to a home equity loan in that you’re borrowing against your home’s equity, but as a line of credit instead. Similar to using a credit card, you borrow from the HELOC and repay it as you go. Again, your home is collateral in this deal, and defaulting could mean you lose it through foreclosure.
• Balance transfer card. Much like it sounds, a balance transfer takes the balance from one or more credit cards and moves it onto a new card, and in many cases, one with a 0% APR introductory period. This period typically lasts for a year, and if you can pay off the debt within that time frame, you can save yourself from high interest charges. A year may be too short a time for some debts, though, so if you have a high balance, you may want to consider other ways to get out of credit card debt.

Get A Personal Loan

A personal loan can act as a debt consolidation loan and can be used for many different expenses. You can use the loan to pay off your debts, and then you’ll only have the one loan to worry about.

Getting a personal loan is a relatively straightforward process that starts with you finding the right lender, as different lenders offer different rates, terms and amounts.

Rocket Loans® can lend up to $45,000 for a debt consolidation personal loan, and offers same-day financing, meaning you could receive your money the same day you’re approved.*

Getting out of debt can seem impossible sometimes, but how you approach your repayments can make all the difference. Decide whether you want to pay off your loans with the highest interest rates first, or knock out those with lower balances. A combination of the two can often yield ideal results.

Aside from those approaches, there may be refinancing options available for your loan, or debt consolidation loans to more easily manage your debt.

If you’re considering a personal loan for debt consolidation, get started today with a prequalification from Rocket Loans.

Disclaimer: Same Day Funding available for clients completing the loan process and signing the Promissory Note by 1:00PM ET on a business day. Also note, the ACH credit will be submitted to your bank the same business day. This may result in same day funding, but results may vary and your bank may have rules that limit our ability to credit your account. We are not responsible for delays which may occur due to incorrect routing number, account number, or errors of your financial institution.