Should I Pay Off Big or Small Debt First?

Getting a Handle on Debt Relief Strategies

Debt is, without question, one of the biggest issues facing people in the United States today. According to the Federal Reserve Bank of New York, America’s overall debt reached a record $13 trillion in 2017—up from $280 billion in 2018.

As a result, knowing how to prioritize debt repayment is an essential skill. Indeed, effective debt relief strategies can build financial security, increase your future earnings, and give you the peace of mind you deserve.

Unfortunately, there is no one right way to climb out of debt. Every person’s situation is unique; as such, each case needs to be handled in a specific way.

Many financial advisors tout the effectiveness of paying off big debts first, but many others say it is best to tackle small bills before the rest. Which approach is right for you? Here are six questions you should answer as you form your plan:

How Organized Am I?

First, those learning how to prioritize debt repayment need to get organized. Proper debt relief plans cannot be made if you don’t have a firm grasp of your overall finances. So if you have not done so already, you should make a spreadsheet listing out each debt, the type of debt, the interest rate, the term, and the credit limit, if it applies. That way, you can gain a strong sense of what you are up against.

What Kind of Debt Do I Owe?

American debt

Everyone building debt relief strategies needs to understand that not all debt is inherently bad. Believe it or not, there is a such thing as “good debt.” In essence, a financial obligation is considered good debt if can help you make money and boost your net worth.

Student debt is one example. According to the New York Times, student loan debt makes up over 11 percent of the total debt in America. While paying off school loans can be an arduous task, receiving quality education can have a substantial, long-term effect on the quality of your life. When schooling is effective, it opens you up to new jobs and, by qualifying you for higher salaries, can give you a high return on investment. Real estate, business ownership, and investments can be considered good debt, as well.

Conversely, bad debt is any form of debt that does not have the ability to enhance your life. Credit card debt fits the bill, and, 41.2% of American households have this type of debt. This liability is created when one spends too much money with credit cards and cannot make their monthly payments. As time wears on, interest rates and late fees make the debt more expensive. When someone uses a credit card to buy a giant television and is unable to pay the necessary installments on time, that person has accrued bad debt.

Conventional wisdom states that you should pay off your bad debt first. This is the case for a number of reasons.

First of all, bad debt from credit cards, unsecured loans, and car title loans tend to have high interest rates. Additionally, many forms of good debt, like student loans and mortgages, have lower interest rates and are tax deductible. If you make regular payments on your good debt, and go out of your way to eliminate your bad debt, odds are you will be off to a good start.

Which Debts Have the Highest Interest Rate?

While it often makes sense to eliminate bad debt first, not all debt relief strategies can be so black and white. Many people wind up with awful student loans that have high interest rates and short repayment terms. Conversely, there are lots of decent automobile loans to be had.

Once you have made your spreadsheet, you should determine which obligations have the highest interest rates. These, by definition, will become more expensive to pay off over time. So it makes sense to get rid of them as fast as possible.

Also known as the “avalanche” method, targeting high interest rates first will save you money in the long run. Many people efficiently get out of debt by paying as much as possible toward their loan with the highest interest rate and making the minimum payments to the rest of their bills every month. Once they have finished paying for the loan with the highest interest rate, they move onto the second-highest, then the third-highest, etc.

Some avoid this approach because it does not provide constant rewards. This is understandable, as it can be demoralizing to make lots of payments and not see the number of obligations dwindle. It can feel great to knock out the smaller debts in short order, but, ultimately, extinguishing your highest interest rates first will save you money.

What is My Credit Score?

Understanding your credit score is critical any time you are working on debt relief strategies and learning how to prioritize debt repayment. In short, your credit score is a number that sums up your financial life. It is updated every month by three major credit bureaus: Equifax, Experian, and TransUnion. Your score is important because it shows lenders how likely you are to repay your debts.

Generally speaking, here is how the different scores break down, courtesy of Equifax.

  • 300 to 579 is considered new or bad credit
  • 580-669 is considered fair credit
  • 670-749 is considered good credit
  • 750 and higher is considered excellent credit

If your score is low, you need to ask yourself the following question…

Do I Plan on Making a Big Purchase in the Near Future?

If the answer is yes, then it is important to raise your credit score quickly.

Low credit scores can make it difficult to buy a house, purchase a car, or get a new line of credit. Moreover, when someone with a low score does receive one of those things, they almost certainly have to pay higher fees and interest rates. This is because they are dubbed “high-risk borrowers.”

One of the best ways to boost your score is to pay off your big credit card debts first. So if you need to get your score up fast, that is a method you should apply to your debt relief strategies.

Should I Consult with Professionals?

At Liberty Debt Relief, we have the experience needed to help you generate a sound plan. We take pride in our ability to take the confusion out of debt relief, debt consolidation, and debt settlement.

Our team of experts can construct debt relief strategies for people of all ages and circumstances. If you want to learn more about how to prioritize debt repayment, contact us soon.

Good Debt Vs. Bad Debt: What Each Does to Your Credit

The Value Getting Relief From Debt

Every day, millions of Americans grapple with financial woes. Households in this country owe more than $13 trillion in overall debt, per a 2017 study, and, as of March 2018, the average home that carries debt owes more than $130,000. The latest information from the U.S. Census Bureau states that the median household income is only $59,039. Put all these numbers together, and it is clear many Americans are living beyond their means, especially when it comes to their unsecured debt.

If you are trying to get a grip on your finances and receive relief from debt situations, you may be presented with some difficult questions. Should you consider a settlement? What kind of relief is possible? How bad does debt consolidation hurt your credit score?

Certainly, there are a lot of different strategies worth exploring. Before you do so, however, you need to understand a few key concepts. One is the difference between good debt and bad debt.

Good Debt (Yes, It Does Exist)

The term “good debt” may seem like an oxymoron, but it does make sense. In essence, a good debt is any financial obligation that can improve your life. A mortgage can be considered a good debt because it gives you a place to live and, with some luck and shrewd management, can appreciate in value.

Student loans fit the bill, as well. Although adults throughout the country are struggling to make these payments—Americans owe nearly $1.5 trillion in student loan debt—a good education can lead to many professional opportunities and a higher income. Additionally, if you take on a loan to start your own business, that qualifies as good debt, because, if all goes according to plan, it will pay for itself—and then some.

The Fact About Bad Debt

Bad debt, on the other hand, comes from any kind of item that becomes less valuable the second you buy it. Credit cards, for example, are a common cause of bad debt. The vast majority of credit card purchases are paid off with interest rates included. That means, over time, you will pay above and beyond the original price. Payday loans, car loans, and furniture loans fit into this category, too. All this makes getting relief from debt a complex process.

wallet full of credit cards on a table

Your Credit Score

As it turns out, good debt tends to affect your credit score in a different way than bad debt. Before getting to that distinction, though, let’s take a look at how important debt is to your credit score in general.

Whether you are getting your credit score from Equifax, Experian, or TransUnion—the United States’ three credit bureaus—debt will play a big factor. Overall, debt accounts for 30 percent of your credit score. It is understandable why that figure is so high: Debt level helps lenders understand how risky a consumer is compared to the rest of the population.

Revolving and Installment Debts

It would be nice if all relief from debt immediately affected your credit score positively, especially if it’s relief from bad debt. Truth is, when it comes to your credit score, the more important distinction to make is not one between good or bad debt but is instead the one between revolving debt and installment debts. Credit bureaus like to see a mix of the two, but they are different in many ways.

Revolving Debt: This is easy to obtain, and it is easy to misuse. It is composed of open-ended accounts and usually has variable interest rates and predetermined credit limits. Credit cards and credit lines are common types of revolving debt.

When you are dealing with a revolving debt, you do not have to pay a certain amount each month. Specific loan terms are not required, either, and you can borrow money as you feel the need, provided you do not reach your credit limit. Typically, these loans do not have an end date; if you make the minimum payments each month, along with the necessary fees, it can remain open.

Installment Debt: Conversely, installment debts are paid in fixed amounts over a rigid period of time. Ordinarily, these obligations come with a fixed interest rate, too, so when the loan is agreed upon, the borrower will know exactly how much he or she will have to pay, and exactly when the loan will end.

Usually, but not always, good debts come in the form of installment credit, as mortgages, student loans, and private personal loans tend to fall into this category. Given how expensive these obligations can be, borrowers want to pay fixed interest rates on them. It is not advisable to take out a mortgage or a five-figure university loan if the interest rate can increase over time.

Debt and Credit Score

Being responsible with an installment loan is a great way to improve your credit. While your score may dip right after the loan begins, that should quickly change as long as you send in the compulsory payments when they are due. Indeed, people who make all of their payments over a years-long span show they are reliable borrowers, and, as a result, see their scores move in the right direction.

Unsurprisingly, revolving debts are the source of most efforts to gain relief from debt. That is because a big part of your credit score is determined by how much you owe compared to your available credit. This is known as the credit utilization ratio. If you are using more than 30 percent of your available credit, you should expect to be penalized in the form of a lowered score.

With installment debts, credit utilization ratio is not a big concern, as you know all of the specifics involved. But when it comes to credit cards, you need to monitor how much available credit you are using. You should avoid going above the 30 percent threshold whenever possible.

Receive Debt Relief Today

In most instances, relief from debt can reduce your credit score. As Americans try to accomplish this, they often ask how bad does debt consolidation hurt your credit score, and while the answer varies from case to case, it is usually substantial.

stamping checkbook

There are better ways to deal with unsecured debt than consolidation. At Liberty Debt Relief, we can provide the answers you seek, and we can provide a clear path forward.

If you are ready to receive a free consultation and learn how we can offer effective relief from debt, reach out to us today.

What is an Example of Bad Debt?

Bad Debt in America

Millions of people today struggle with all different types of debt. According to a Federal Reserve Report on the Economic Well-Being of U.S. Households, published in May 2017, 79% of Americans have at least one credit card. This means that millions of Americans are faced with credit card debt and have to manage their finances accordingly. Debt can be very stressful and overwhelming, especially as your balance continues to grow.

As you think about your financial well being, it can be very confusing when you constantly hear terms such as good debt and bad debt. You may even be wondering what these terms mean and how debt can be bad or good.

What is Bad Debt?

This type of debt is incurred from purchasing assets that depreciate or go down in value as soon as you buy it, such as clothing and consumable goods. If you are unable to make money or generate income for a purchase, it may not be worth going into debt over. Purchasing a new car is another form of this kind of debt because, as soon as you purchase a new car and take it home, it has already gone down in value.

Another typical example is credit card debt. Credit cards are designed to make sure that you pay the maximum possible with high-interest rates. They can also have an extremely negative impact on your finances if not appropriately managed. If you keep a balance on a credit card, it will end up costing you significantly more than what any item or service you buy is worth. This is especially true if you only make the minimum payment every month. Credit cards are seen as one of the worst examples, but there are others.

What is Good Debt?

Good debt is seen as “good” because, ultimately, it is used to help you generate income or increase your net worth. Short term investing and real estate investment loans are just two examples. The most well-known example today, however, is student loan debt. As the costs associated with higher education continue to rise, it is becoming increasingly more difficult to pay for college.

Taking out student loans to fund your education can be good because the loan will eventually pay for itself once you finish school and can find a job. Individuals who have a college education consistently out-earn those who do not have a college degree, so this can be seen as an investment in your future.

Another example of good debt is taking out a small business loan to help grow your business. Creating your business is a great way to generate income and potentially increase your network as well, similar to small business loans are loans for short-term investments.

Managing Your Debt

To stay on top of your debt, it is important to actively manage your debt and work towards eventually becoming debt free. Having a mix of good and bad debt is normal, but it is important to limit or pay down the latter quickly to stay on track with your financial goals.

If you need help with your bad debt and regaining control of your finances, it may be worth it to meet with a certified debt specialist to come up with a comprehensive debt relief plan. Meet with ours at Liberty Debt Relief, and explore multiple debt relief options and ways to get back on track to financial freedom.