What is the Best Way to Prioritize Debt?

Debt can be prioritized via a few different categories but it really depends ultimately on what your goal is. Most commonly creditors categorize debt via the nature of their securitization, in other words whether the accounts are secured or unsecured. They do this because unsecured debt is considered to be the least desirable version of debt one can carry, simple due to the fact that there is more associated risk with noncollateralized debt. When no property is attached to a debt obligation, there is a higher risk that the lender is not made whole should a borrower be unable to repay what they borrowed.

Otherwise, as a consumer you can always look to prioritize the accounts that are the highest interest rate first or the lowest balance if you are trying to increase monthly cashflow or trying to lower your debt to income ratio. There is no one size fits all for consumers, but typically speaking, consumers will tend to prioritize debts via their size or the interest rate, while creditors and lenders will tend to prioritize debts by their category and whether they’re secured or not.

Prioritizing by Payment Amount

This option is going to be best for those that want to improve their debt to income ratio as quickly as possible. If your goal is to reduce your monthly debt obligations and increase your overall monthly cashflow you will want to prioritize debts by monthly payment amounts. To do you this you will want to ignore large sized debt amounts and instead focus on paying down the accounts with that are closest to $0 and accounts that have the highest monthly payments. The easiest way to do this is typically by paying down the accounts closest to $0. However, if you don’t have many accounts near zero you will want to focus on the ones with the highest payment amounts first.

Prioritizing in Order to Boost Credit

If you want to prioritize based on what will improve your credit the quickest you will want to prioritize them in terms of both securitization and utilization rate. Secured debts always have a higher priority than unsecured accounts simply because lenders favor them more heavily and they positively impact the credit worthiness instead of negatively.

Secured Accounts

Prioritizing based on secured accounts will help you with categorization of your debts. Secured accounts are accounts like mortgages, second mortgages, home equity lines of credit, auto loans, etc. They are a net positive for credit simply because they are perceived as less risky from the creditor’s perspective and they allow borrowers to borrow based on assets or property so should a borrower default the lender has rights to property that could help them recoup some losses.

Unsecured Accounts

Unsecured accounts are considered to be bad debt in that sense that too much unsecured debt could be damaging to credit. They are also the more risk laden as opposed to secured debts which are tied to collateral. The difference for lenders is that unsecured loans and unsecured debts are not tied or collateralized to assets so if the borrower is unable to repay there is not asset or property that can be taken for repayment.

Prioritizing by APR

Prioritizing by APR is a great way of going about things as this will allow consumers to prioritize in terms of what saves them the most amount of money. By paying off the highest priority accounts first, you can then have less of your payments allocated towards interest each month. The highest cost is often associated with the accounts with the highest interest rate so when you do this, you can start saving money ASAP.

Prioritizing by Balance

Prioritizing based on balance will help consumers get a better feel for the total amount of debt they owe. When you prioritize by balance your ultimate goal is indiscriminately get rid of the highest balance accounts first at any cost. Although this is typically not the most cost-effective way to go about eliminating debt it’s definitely a way you can go about it.

You can prioritize debts anyway you want depending on your priorities. Whatever the case may be however you decide to categorize debt it will help to know what your ultimate goal is and how you plan on using the money in paying down debt.

If your main goal is to aggressively pay down debt as indiscriminately as possible you should just look towards paying down debts by the highest interest rate as this will eventually provide the most substantial savings. If you goal is save on interest you should prioritize based on interest rate. If your goal is to prioritize based on credit your goal should be to eliminate all unsecured accounts first and improving your utilization rate. If your goal is prioritize based on improve your debt to income ratio you will want to eliminate accounts with the lowest dollar amount and with the highest monthly payments.