Pay Off Low-Interest Debt First To Boost Cash For Savings

Paying off the lowest interest debt you have can boost your cash flow and provide money needed to start addressing higher-interest debt or put together an emergency fund.Photo by The Comedian.

The Simple Dollar suggests that eliminating low-interest debt first puts you in a better position to choose what to do next: pay off or tread water on other debt, plan for emergencies, or save and invest. Increasing cash flow offers more options.

Conventional wisdom says you should pay off the debt that costs the most first and then use the "snowball method" to pay off lower-interest debt, but cash on-hand is important too. What do you think: do you pay off low-interest or high-interest debt first? Share your tips in the comments.

Why Should I Hurry to Pay Off Low Interest Debts? [The Simple Dollar]


Comments

    Paying off the smallest debts first is from my experience the way to go. Don't look at the interest rate but look at how much is owing and get rid of the small debts first. This then frees up those monthly payments to top up the next smallest debt. Also worth noting in order to truly get out of debt you need to save all year for things like Christmas, rego and insurance which is where those high interest bank accounts come in handy.

    Not sure on what the article is really getting at - if you have to pay off low interest debt first, wouldn't that mean your home loan then the credit cards?

    I'd have thought as @krnageskillz says above; attack the smallest balance of debt first, then roll it up to the next one.

    I tend to find the small balances are the highest rates anyway.

    This is the worst advice ever.

    If you owe $2,000 on your credit card at 18% (some are much higher), vs a personal loan at 13%, vs a mortgage at 8%, you pay off the card first.

    LG makes a good point though, as a general rule the smaller the balance, the higher the rate.

    Also, if you pay off your credit card instead of saving the money, you're effectively getting 18% on that money, and if you do need money for an "emergency," you have a credit card ready to use, rather than one that is at it's limit.

    And don't even get me started on "debt consolidation"....

    (I do this stuff for a living btw)

    I just read the original article and I think you've misinterpreted it. The article states that you should try to pay off debt even if it is low interest, to free up your cash flow. It doesn't mention whether you should pay it off first or later, just that you should try to pay it off as well as high interest debt (which it's a bit more obvious that you really should pay off).

    Oh dear, what terrible advice. As Lachlan said once you've cleared your credit card, you have that as your emergency reserve. There's no need to stockpile cash (where you will also be taxed on interest earned) if you have a zero balance drawdown facility that you can dip.

    There is research to show that clearing down one debt is good for morale and will keep you on track with future efforts but other than this always tackle the highest rates earliest.

    Generally they are not referring to home loan debts, rather credit cards/store cards/personal loans.

    Plus the thinking behind behind paying off smaller debts first is more psychological than pure math based.

    Lachlan is right, it should be done at the higher interest rate first. In a years time, the $2000 paid off the credit card means that credit card is $2,360 better off than if you left it, the same $2,000 off the home loan on year later is $2,160 of benefit. I think this is not such a hard concept so I won't dwell...

    There are absolutely psychological benefits, which, if you are talking about committing all your funds to reducing debt, these psychological benefits can assist in the personal reward and longevity and sustainability of the strategy.

    If it is the case, that you are committing all funds to debt reduction, then it is likely that you will require emergency funds, or funds for bills or a nice dinner to let yourself know you are doing well in achieving the results you seek (ironic, I know). In this case it is best to have paid down the debt that you can access again such as credit cards rather than a store card, where a $0 balance only means you can buy new furniture or a TV - unnecessary. Even if the credit card had a lower interest rate than the store card, meaning $2000 paid off is worth ~1% or ~2% more if paid off the store card, it may be worth that difference to have the access if required.

    To begin the process anyone should look for a promotional balance transfer offer to take the full credit card (or store card) debt and lock it in at between 2% - 5%, then make additional repayments off others until the credit card amount is due.

    NEVER LET A BALANCE TRANSFER EXPIRE - You will often be penalised as if you never had the balance transfer to begin with, they may back charge the full term at the full interest rates.

    If you have a redraw facility on your home loan the balance transfer debt is less rewarding than reducing capital on an 8% home loan during the 6 months, or year or whatever term the balance transfer allows. Then redraw the amount owing on the credit card to zero the balance. Now you have only the home loan to focus on and a fully accesible balance on a credit card in case you get in a tight spot, if you do need it pay off the credit card at the required 55 days from purchase date so you don't find yourself in this position again.

    Crappy advice. You misinterpreted the original article. Sorry.

    Really, really terrible advice. Consolidation loan would be a much better way to approach cashflow consolidation. If you don't want to consolidate, always pay off the highest interest rate, or lowest total first. Lowest total to reduce cash flow burdens, highest interest to reduce total cost of your loans.

    This isn't sound advice. step 1: target high interest Step 2: target smallest loan of the high interest pool. I think this article should be taken down or at least re-written. Makes me wonder about the credibility of other articles now... which makes me sad because I love this site.

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