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Debt Payoff Strategies: Which One is Right for You?

Paying off debt can be a daunting task, but choosing the right strategy can make a significant difference. In this article, we’ll explore various debt payoff methods to help you decide which one suits your financial situation best. Whether you prioritize high-interest debt or the highest balance, O1ne Mortgage is here to assist you with all your mortgage service needs. Call us at 213-732-3074 for expert advice.

When to Consider Paying Off Debt With the Highest Interest First

If your goal is to save money, focusing on high-interest debt is often the best approach. This method, known as the debt avalanche, targets the balances that cost the most to carry.

For example, as of the first quarter of 2024, the average annual percentage rate (APR) on credit cards was over 22%. If you have a $5,000 balance on a credit card with a 20% interest rate and make a $150 payment each month, you’ll pay an extra $2,359 in interest over four years. The faster you eliminate this balance, the more you’ll save.

Here’s how to implement the debt avalanche method:

• List all your debts, including balances, minimum monthly payments, and interest rates.
• Continue making minimum payments on all accounts.
• Put any extra money toward the balance with the highest interest rate.
• Once that account is paid off, focus on the next highest rate.

Example of Paying Off Highest-Rate Balances First

Consider the following debts:

• Student loan of $4,000 at 7%
• Credit card balance of $3,000 at 20%
• Credit card balance of $6,000 at 18%
• Personal loan of $5,000 at 12%

With the debt avalanche strategy, you’d prioritize the credit card with the 20% interest rate, even though it has the smallest balance. Once that balance is paid off, you’d move on to the next highest rate.

When to Consider Paying Off Debt With the Highest Balance First

If you plan to apply for a mortgage or other loan soon, reducing your highest balance might be more beneficial. This approach can lower your credit utilization ratio, which is a key factor in your credit score.

For instance, if your total credit card limits add up to $10,000 and your current card debt is $5,000, your credit utilization rate is 50%. Lowering this rate can improve your credit score, making it easier to qualify for new credit with favorable terms.

How to Choose a Debt Payoff Strategy

Your balances and interest rates will determine the best strategy for you. Here are a few options:

• Debt avalanche: Prioritizes the balance with the highest interest rate to save money in the long run.
• Paying off the highest balance first: Reduces your credit utilization rate, making you a more attractive borrower.
• Debt snowball: Focuses on paying off your smallest debt balance first, providing quick wins to boost motivation.
• Debt consolidation: Involves taking out a new loan with a lower interest rate to absorb your current balances, or using a balance transfer credit card with a low or 0% introductory rate.

The Bottom Line

Is it better to pay off higher-interest loans first? It depends on your financial goals. If saving money is your priority, the debt avalanche method is worth considering. However, if you’re looking to secure new financing, prioritizing your highest balance might be more beneficial.

Paying down debt can improve your credit score, which is crucial for future financial opportunities. For personalized mortgage advice, contact O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey.

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