Prioritize Your Debts

If you're knee-deep in debt, getting back in the black can be a long, arduous road. Unless you've won the lottery, it seems there's never enough money to pay off all your debts as quickly as you'd like, and if you're running really short on cash, just staying afloat can be a Herculean task. If you can't do everything, you've got to prioritize. Prioritizing your debts can help you pay them off as quickly as possible, and it can provide the security you need to get back on your feet even in lean times. Best of all, you can prioritize your debts on your own, and doing so may help you avoid the need for potentially costly credit counseling or debt management programs.

Steps

 * 1) Start now. No matter what your financial situation, as long as you have debts or regular bills, you should prioritize them. Don't wait until you're about to lose your house or are otherwise in a serious debt crisis, because by that point you'll probably need more drastic solutions.  Prioritizing your debts, along with making and following a budget, can keep you from getting buried in debt and can help you solve minor debt troubles.
 * 2) Get all your paperwork together. In order to prioritize you need to at least know the interest rates (and, sometimes, other fees), balances, and minimum monthly payments for each debt you have.  You may also need to review other terms and conditions of your loans and credit cards.  A calculator is invaluable for crunching the numbers.
 * 3) *Be sure to consider fees that may affect your priorities. For example, some credit cards have annual fees that you can avoid if you pay off and cancel the card.  Some loans have prepayment penalties, which may make quickly paying those loans off less cost-effective than it would be if you had only to consider the interest rates.
 * 4) *If the interest rate on a particular account is subject to change, as is the case with credit cards that have introductory rates, be sure to consider this. Your priorities may need to change when the rates change.
 * 5) *When prioritizing by interest rates, use the effective interest rate, the rate that takes into account any tax deduction. This is usually applicable to mortgages or student loans.  Since interest payments on these loans are tax-deductible, the cost of such loans is actually a bit less than the stated interest rate.  Calculate the effective rate by multiplying the stated interest rate by 1 minus your income tax bracket.  For example, if you're in the 30% tax bracket and you have a mortgage with a stated rate of 10%, the effective interest rate is 7.0% (10*(1-0.30))
 * 6) Determine what strategy you need. If you're living comfortably and securely, your goal should be to prioritize your debts so as to pay them off as quickly as possible.  If you're just barely scraping by, however, you should prioritize to make sure you have the necessities now while trying to minimize potential problems down the road.  Each situation requires a different ordering of your priorities.
 * 7) *Strategy 1: Pay off debts fast. Debts can most quickly be paid off using a "snowball" technique.
 * 8) **Put your debts in order from the one with the highest interest rate to the one with the lowest.
 * 9) **Pay the minimum monthly payments on all your debts except for the one with the highest interest rate.  Make sure to keep all your accounts in good standing.
 * 10) **Pay as much as you can on the first debt. In general, the quickest way to pay off all your debts is to first pay off the debt with the highest interest rate (usually a credit card or personal loan), so each month you'll want to pay as much as possible on that debt.
 * 11) **Focus on the debt with the next-highest interest rate once you've paid off the one with the highest rate. Once you've paid off that one, proceed to the next-highest, and so on until you're debt-free.
 * 12) ***Example:
 * 13) ***You owe $1500.00 on your Acme Bank credit card with a 13% interest rate, and it has a $70.00 minimum payment per month. You owe $2500.00 on your FoosBank credit card with a 10% interest rate, and it has a $200.00 minimum payment per month.  You can afford to pay an extra $100.00 per month to your credit cards.  Pay $200.00 per month on the Acme card, and keep on paying the minimum payment on the other one.  Once you have paid Acme down to $0.00, apply that $200.00 a month to the FoosBank card - now you are paying $400.00 per month on the FoosBank balance, and it will be paid off within 5 months if you kept it up to date while paying off the other card!  That's the "snowball" effect.
 * 14) *Strategy 2: Prioritize to stay afloat. If you're having trouble making ends meet, take care of the bare necessities, like food, first.
 * 15) **Keep a roof over your head. If you own your home, the mortgage payment is your highest-priority debt.  In the U.S. lenders will typically begin foreclosure proceedings after three missed payments, though this may vary.  Even if you get just a month or two behind, you may have trouble getting your payments back up-to-date, which can cause you problems down the road.  If you rent, you can usually be evicted after just one missed payment, and then you'll be faced with finding another place to live with a huge blemish on your record.
 * 16) **Pay your utilities. Power, water, and other utility companies will usually give you some leeway in missing payments, but if you get too far in arrears, they'll shut off your service, which can make everyday living very difficult and can also make it more costly to get service in the future.  If you can't pay your bills in full, call the company and see if you can work out a payment plan.  They're usually very accommodating.
 * 17) **Keep your car. If you need your car to get to work or to find work, it's important that you keep your payments up-to-date.  Finance companies can repossess cars fairly easily, and in many cases they don't even have to give you notice.   Make sure to pay your insurance, as well, because it's the law and because if you don't the lender will add their own insurance, which will cost you far more while only protecting the lender's interest.
 * 18) ***Do your best to save money on gas.
 * 19) ***Consider carpooling.
 * 20) ***Have you considered living without a car?
 * 21) **Pay child support. Failure to pay child support can land you in jail.
 * 22) **Pay taxes. Failure to pay property taxes can cause your property to be seized. Failure to pay income tax, in extreme cases, especially when criminal activity has taken place, can send you to prison.
 * 23) **Pay student loans. The government backs student loans, and if you go into default they can take collection actions that other creditors can't.
 * 24) **Pay your lower priority debts. Credit cards, loans secured by household objects, personal loans, and store charge cards are not high priorities.  Pay the minimums on all these if you can, but if you have to choose between your credit card bill or your mortgage, choose your mortgage. Call your credit card companies and tell them you need either deferment or lenience.  If you call and let them know you are in trouble, most are willing to work out a payment plan by temporarily lowering your minimums or deferring payment for a couple of months until you are working again, etc.  If you blow them off, though, they will be angry and less apt to work with you.
 * 25) **Pay medical bills. Medical bills offer a bit more leniency than most other kinds of loans, and even if they go on your credit report they're generally looked at differently than other missed payments.
 * 26) **Bring accounts up-to-date as soon as you can. Once you've gotten back on your feet, get all your accounts current if you've fallen behind on them.  Focus on the ones on which you are the furthest behind.  Once everything's caught up, start prioritizing to pay debts off quickly.
 * 27) *Strategy 3: Improve your credit score. Start by paying off revolving credit accounts (such as credit cards) with the highest balances relative to their credit limits. The "utilization ratio," the percentage of your available credit that you are using, is a key factor in determining your credit score, and lenders use it to determine your ability to pay future debts.
 * 28) **See more in How to Repair Your Credit.

Tips

 * If you can't pay the minimum payments on some of your debts, talk to the creditor and try to work something out. Mortgage lenders are usually very accommodating if you're making a good faith effort to pay your bills and if the situation is temporary.  Even credit card companies will generally work with you to waive fees or temporarily lower your payments.
 * Prioritizing your bills can help you get out of debt, but in order to most quickly achieve financial freedom, you need to also get your spending under control. Look at your spending habits carefully, and cut back on wasteful expenses.  Don't live beyond your means, and don't incur any additional debt.  If your income still can't keep up with expenses, try to get a better-paying job or a second job.  Make these lifestyle changes, and you'll make sure you don't get into debt trouble again.
 * Your priorities may need to change in some circumstances.  If a court judgment is entered against you on an old credit card debt, for instance, that should become a high priority, as the creditor may be able to garnish your wages or take other adverse actions.  That said, if you have to choose which debts you can pay, don't let collection activities influence your decision.  Collection agencies will try all sorts of tactics to get you to pay them quickly, even if you can't afford it.  Don't fall for their tricks, and stick to your guns.  Keep your family fed and your house payments up-to-date before you even think of paying on a defaulted credit card.
 * Sometimes it makes sense to pay off small loans first, even if they don't have the highest interest rates. If you can pay a debt very quickly, you'll have one less bill to worry about, and getting even one bill paid off may give you the motivation you need to proceed on the road to becoming debt-free. You can build up lots of momentum if you have 4 or 5 small credit cards paid off, rather than waiting for a larger, high interest rate debt to be paid off.
 * Another helpful technique is to first save up between $500 and $1000 in an emergency fund (to pay for the transmission when it breaks, not happy meals when you don't feel like cooking) before starting the snowball. Once you have that, cut up the credit cards and start the snowball. This way, you don't run the risk of needing to go back into debt when an unexpected expense occurs.

Warnings

 * Always think about the consequences of late payment, and customize your priorities around special circumstances. If you owe a shady loan shark, and he might break your legs, for example, that debt should move to the front of the line.
 * Individual financial situations and obligations vary considerably. This article should only be considered a general guide and is not intended to replace professional legal or financial advice.  Prioritize your bills according to your unique situation.
 * Sometimes it makes sense to invest extra money instead of using it to pay down your debts. For example, if you have a loan with a 7% interest rate, but you can get a return of 15% by investing your money, you'll actually be better off investing.  This strategy, called leveraging can be dangerous, because the rate of return on most investments is subject to change.  Worse yet, many investments can unexpectedly decline in value, so you might actually end up losing money.  In any case, be sure to at least pay your minimum payments on all your debts before investing.
 * Credit card companies will often times "scream the loudest" (i.e., bother you the most often) when it comes to collecting debt. This does not mean that they are high priority debt, even if they tell you that they are. Remember that there are laws to protect you from unreasonable debt collection measures (harassment, threatening speech, etc.).

Related Tips and Steps

 * How to Decide Whether to Invest or Pay off Debt
 * How to Repay Your Debts
 * How to Budget Your Money
 * How to Budget and Save on a Small Income as a Single Parent
 * How to Decorate Your Home on a Budget
 * How to Get Your Home Redesigned While Staying on a Budget
 * How to Become Organized
 * How to Start Living a Debt Free Life