Which Type of Debt Should You First Repay?

Which Type of Debt Should You First Repay?

Some people are in too much anxiety when getting into debt; hence, wanting to pay it the soonest they can. However, if you have obtained all sorts of debts, you might be in doubt about which debt to settle first, what to focus on and which type to pay first.

The first part that you need to recognize is that there are debts that are much better than others. In fact, these debts are mostly referred to as good debt. These debts are associated with approximately low-interest charges that would belong into the classification of good debt.

For instance, lines of credit and home equity are debts that accumulate low-interest rates. In comparison to your credit card debt, these debts are way better. Additionally, mortgages, as well as student loans, also tend to carry low-interest charges, which are then classified as good debt.

Reason Why Good Debt is Considered Good

The main reason why good debt is perceived as good is due to the low-interest charges. Having this type of debt allows you to pay it slowly and utilize the extra money to save or invest rather than to facilitate your debt repayment. By doing so, you can initiate a better investment return.

For such reason mentioned, several financial professionals recommend not to pay your mortgage too fast. This is because you might miss out on the chance to leverage your money through retirement investment.

Reason Why Bad Debt is Considered Bad

On the contrary, bad debt is any debt that carries high-interest charges, which hinders you to free up some money, which you are supposed to spare for your retirement contribution. These types of debts are usually hard to eliminate considering that most of the payments made will go towards your interest rather than to your debt principal.

Repaying Bad Debt First

For a person carrying several types of debt, deciding which to pay first must be based on the debt that holds the highest interest rates. The following are mostly the debt that you should settle first:

Credit Card Debt

Usually, credit card carries the highest interest charges among other kinds of debt in exception to payday loans. Several people will pay approximately from 15% to 30% interest on their credit card. Considering that this amount of debt is significant, it can be crucial for you to sustain the necessary payments.

Moreover, if you have multiple credit cards, you can pay first the card that incurs the highest interest rates. Besides, you can consider a debt consolidation loan to lower your monthly payments.

High-Interest Installment Loans and Lines of Credit

If you carry installment loans with high-interest rates like car loans, or any other kinds of loan that accumulates an interest charge that is beyond 7%, this debt must be your next priority. Since 7% is nearby the average valuation of return, you might be required to secure or invest the money if you are meeting a higher portion of interest than on any loan; then, you should concentrate on expediting your payment on these kinds of loans.

Repaying Good Debt

Home Equity Lines of Credit (HELOCs) or Home Equity Loans

Though HELOCs and home equity loans incur low-interest charges, it can seldom be higher than the amount you pay for your mortgage or even on student loans. If this is the case, you should concentrate on restoring this debt. This can be essential if you consider the idea of selling your home considering that you’ll be able to pay your HELOC after such sale. Conversely, if the value of your home reduced, it is possible that you might be unable to cope up with the repayment.

Student Loans

Student loans are considered good debt since it enables you to obtain a higher level of education, which can possibly increase your income in the future. However, if you’re paying beyond 7% on your student loan debts, accelerating your payments might not make sense; rather, you can have the money invested for savings or retirement.

Mortgage

If you possess a mortgage and might despise your monthly payment, you might feel having it paid as quickly as you can. Though this is a great idea to pay off your mortgage, it might not be possible for you to start building an emergency fund or start an investment as your money is totally tied up to your mortgage.

Debt Repayment

As you repay good or bad debt, you have to weigh in your options and know how much will you spare to pay it down. There has to be a balance and your action plan should be attainable to target your financial goals. Furthermore, you must ensure that you also have to contribute for your retirement. The key will somehow depends on your attitude and strategy.