Is it better to pay off high interest or high payment?

The Debt Duel: High Interest vs. High Payment – Which to Tackle First?

Debt. The word alone can trigger anxiety for many. When faced with multiple loans, the question often arises: should you prioritize paying off high-interest debts or high-payment debts? While both approaches have merit, focusing on high-interest debt offers a more financially sound and ultimately less stressful path to freedom.

The allure of tackling the high-payment debt first is understandable. Seeing a large payment disappear quickly provides a psychological boost, a sense of accomplishment that fuels motivation. However, this approach can be financially counterproductive in the long run. By focusing on the larger payment, you may be ignoring the insidious power of compound interest accumulating on smaller, higher-interest loans.

The debt avalanche method offers a superior strategy: prioritize high-interest debts. This approach recognizes the crucial role of interest in escalating your overall debt burden. Let’s illustrate with an example:

Imagine you have two loans:

• Loan A: $5,000 balance, 20% interest rate, $150 monthly payment.
• Loan B: $10,000 balance, 5% interest rate, $300 monthly payment.

Intuitively, you might focus on Loan B due to its higher payment. However, Loan A is accruing interest at a significantly faster rate. The $150 payment barely covers the interest each month on Loan A, meaning you’re barely chipping away at the principal. This slow progress allows interest to compound aggressively, costing you more money over time.

By applying the debt avalanche method, you dedicate extra funds towards Loan A, the higher-interest debt. Once Loan A is eliminated, you redirect those freed-up funds towards Loan B. This strategy minimizes the overall interest paid, leading to faster debt reduction and significant long-term savings.

While the psychological satisfaction of knocking out a large payment is undeniable, the financial reality is that the high-interest debt is a bigger threat. The compounding effect of high-interest rates quickly outweighs the perceived benefits of tackling a larger payment first.

The benefits of the debt avalanche method extend beyond just financial savings. By focusing on high-interest debts first, you experience faster progress, leading to increased motivation and reduced stress. This positive feedback loop can make the daunting task of debt repayment feel significantly more manageable.

In conclusion, while the temptation to focus on high-payment debts is strong, prioritizing high-interest debts through the debt avalanche method is the more financially savvy and emotionally sustainable approach. It minimizes the overall interest paid, accelerates debt elimination, and ultimately leads to a faster, less stressful journey to financial freedom. Remember to consult with a financial advisor for personalized guidance tailored to your specific financial situation.