Finance Question #13 - Should I pay off my highest interest debt, or my smallest debt first?
Often times I get asked where to start when one decides to become debt-free. The first place you should start is your credit report. Your credit report will outline all of the outstanding debts that count towards your credit score. As most of you probably know, there are several websites that will give you a free annual credit report. Just make sure that the website is a credible organization before you fork over your social security number. Before we address the main question, let's quickly cover the first step you need to cross on your quest to become debt-free.
This first step is very important so take note.
Attacking Debts in Collections
In the midst of reviewing your credit report, the first items you need to clear up are any debts that may be in collections because these type of debts inflict some of the most severe damage to your credit score. Debts in collections are debts that have been transferred from the original creditors to debt collections agencies. Collection agencies, formally known as bill collectors, are those who routinely blow up your phone looking for their money.
The good thing here is that you are actually in a position of leverage. What I mean by that is the collection agencies are desperate to get almost any amount of money from you towards the debt you owe. With that said, in most cases, you can negotiate your way into a payment or settlement plan for much less than the original debt amount. This is exactly what the so-called credit repair companies do on your behalf, which I believe is a big waste of money.
Ask yourself; "I am already in debt, so why I am paying out even more money to a credit repair company just to make phone calls to collection agencies that I can easily do myself?" Doesn't make a whole lot of sense does it?
Now, remember whenever you arrange a payment plan with a collection agency to always GET IT IN WRITING before you pay a single dime...very important.
Pay off high-interest debt or small debt first...
Back to the original question; Should I pay off my highest interest debt, or my smallest debt first? Here's the thing, the whole stigma about paying off the smallest debt first is all psychological. Prominent names in the finance world who argue that paying the smallest debts first is for the sole purpose of motivating yourself to continue on with your debt-free plan.
I have two problems with this method. Number one, I am not a big fan of motivation, especially when it comes to becoming debt-free. The reason being is because motivation is temporary, therefore motivation is not very suitable for long-term objectives. Some days you wake up motivated and some days you're not the least bit motivated. So if you are depending on motivation, think of what will happen on days when you wake up grouchy and completely unmotivated? Your debt-free action plan may very well go up in smokes.
Here's an example to further explain my reasoning; One of the most common themes for New Year's resolution people is to exercise and get in shape. After fireworks, champagne, and parties you are super motivated to get in shape for the new year. You go hard at the gym for maybe a good 2 weeks or so, and then all of a sudden your motivation disappears. You then put off 'getting in shape' til the new year rolls around again...not a good plan.
Problem Number two, the act of paying off the smallest debt first instead of the highest interest debt just doesn't make any sense mathematically. Your highest-interest debt will be continuously growing at an alarming rate while you are busy paying off the smallest debts first. In a nutshell, it will take you a lot longer and cost you a lot more money to become debt-free by paying off the smallest debt first.
Attack the highest interest debts first, and save yourself the time of trying to depend on motivation to become debt-free. Instead, just make a commitment and stick with it even on the days when Mr. Motivation is nonexistent.
Take charge of your money!
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Disclaimer: Hudson Wealth Management, LLC (HWM) is a FINRA registered investment adviser firm. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and HWM's fee schedule. The information provided herein is for illustrative purposes only and does not constitute personalized investment advice, recommendations or solicitations to hold, buy or sell any investment or security of any kind. All images and return figures shown are for illustrative purposes only and are not actual customer or model returns. Past performance does not guarantee future results.
Prior articles in this series
MONEY QUESTION #1 - Do you live for today, or live for tomorrow?
MONEY QUESTION #2 - Should I "loan" money to friends and family when they are in need?
MONEY QUESTION #3 - Did grade school (K-12) teach you anything about money?
MONEY QUESTION #4 - Why do I need an emergency fund?
MONEY QUESTION #6 - What is the difference between financial security & financial freedom?
MONEY QUESTION #7 - How can I improve my chances of getting a credit limit increase?
MONEY QUESTION #8 - How much emergency money is needed?
MONEY QUESTION #9 - When Should I Start Saving for Retirement?
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7 年Not dont pay at all lol!!!!