Last week, I talked about what an acceptable amount of debt was and what your debt-to-income ratio means. The next step is to understand how you should prioritize your debt to gain better control of your finances.
In order to properly prioritize your debt, you first need to make a list of all your monthly expenses. Set this up in a spreadsheet, and you’ll be able to build your budget off it later.
Basic human necessities always take priority. Your housing and food costs should be estimated and that money needs to be set aside every month before looking at other debts.
Secured vs. Unsecured Debt
Most debt usually falls under unsecured debt, which simply means you borrow money with the promise to pay it back. Secured debt provides your creditors with collateral, such as your mortgage or auto loan.
Your mortgage should be top priority anyway, as it falls under the housing necessity. Your auto loan will most likely be another top priority, especially if you need a car to get to your job.
Remember, if you don’t pay your secured debts, they can take away the collateral.
The next important debts you may or may not have:
- Tax debts
- Student loans
Both of these debts have flexible payment options, plus you’ll find options if you fall on hard times. It’s important to communicate with the IRS or student loan creditors if you’re going through financial hardship.
Credit card debt can snowball due to high interest rates, so do everything you can to pay off your card every month or at least pay higher than the minimum payment. There are two strategies that are used for paying off cards:
- Paying off the most expensive first – this will be the card with the highest interest rate. Paying interest fees every month just wastes valuable income.
- Paying off low balance cards first – some people find the satisfaction of paying off a card boosts their motivation for improved debt management. Paying off a balance can also help your credit.
You may have other debt that pops up that can go to the end of your list, including:
- Medical bills
- Household items
- Outstanding fees for services
While these do need to be paid, they’re not as important as the debts listed above.
Important Things to Remember
- Collections may be aggressive, but don’t panic. You’ll rarely be sued over a debt as long as you communicate what’s happening, what payments you can make and when you expect to pay off the debt.
- If a court judgement is issued against you, that debt should become a high priority.
- If you have multiple credit cards and other smaller debts, consider getting a personal loan to consolidate to one easy payment with a payoff date.
- You can possibly reduce your monthly expenses by refinancing your auto loan.