If you get money in a lump sum, such as a bonus from your employer or a tax refund, or if your monthly income rises, you’ll have to figure out the best way to use that extra cash. Paying down debt is a good idea, but you might be wondering which debt to tackle first.
How to Prioritize Debt Repayment
It’s generally best to create a debt repayment strategy based on interest rates. Paying off balances with high interest rates will save you more money in the long run than putting extra money toward debts that carry lower interest rates.
Credit cards typically have higher interest rates than mortgages. If you have credit card balances with interest rates that are higher than the rate on your home loan, focus on reducing or eliminating your credit card debt first.
How Paying off Credit Cards Can Improve Your Financial Outlook
The longer you hold onto credit card debt, the longer interest charges will accrue. You can be charged interest for purchases you made, then be charged interest on your total balance. Even if you keep up with the minimum monthly payments, you can find it difficult or impossible to pay down the debt.
Putting extra funds toward credit card bills can help you break out of that cycle. Paying off your credit card balances as quickly as possible can save you hundreds, or even thousands of dollars in interest.
Reducing or eliminating credit card balances can also give your credit a boost. Your credit utilization ratio (the percentage of your total available credit that you’re using) is one of the top factors that’s used to calculate your credit scores. If you reduce your credit utilization ratio, you should see an increase in your credit scores. That can be helpful if you decide to take out an auto or personal loan or refinance your mortgage in the future.
Paying off credit card bills can also give you greater flexibility in your monthly budget. Not having to make large debt payments every month can leave you with more money to invest for retirement, build up your emergency fund, or take a vacation.
Look at the Big Picture
A large mortgage balance and a long loan term can seem overwhelming, and you might be tempted to use extra money to pay off your mortgage faster. If you have credit card debt, though, it can make more financial sense to pay that off first.
Everyone’s situation is unique. Interest rates on home loans are usually, but not always, lower than interest rates for credit cards. Review your recent financial statements and create a plan that’s right for you.
