How to Prioritize Your Debts

If you're knee-deep in debt, getting back in the black can be a long, arduous road. Unless you've won the lottery, it seems there's never enough money to pay off all your debts as quickly as you'd like, and if you're running really short on cash, just staying afloat can be a Herculean task. If you can't do everything, you've got to prioritize. Prioritizing your debts can help you pay them off as quickly as possible, and it can provide the security you need to get back on your feet even in lean times. Best of all, you can prioritize your debts on your own, and doing so may help you avoid the need for potentially costly credit counseling or debt management programs.

1. Start now. No matter what your financial situation, as long as you have debts or regular bills, you should prioritize them. Don't wait until you're about to lose your house or are otherwise in a serious debt crisis, because by that point you'll probably need more drastic solutions. Prioritizing your debts, along with making and following a budget, can keep you from getting buried in debt and can help you solve minor debt troubles.

2. Get all your paperwork together. In order to prioritize you need to at least know the interest rates (and, sometimes, other fees), balances, and minimum monthly payments for each debt you have. You may also need to review other terms and conditions of your loans and credit cards. A calculator is invaluable for crunching the numbers.

• Be sure to consider fees that may affect your priorities. For example, some credit cards have annual fees that you can avoid if you pay off and cancel the card. Some loans have prepayment penalties, which may make quickly paying those loans off less cost-effective than it would be if you had only to consider the interest rates.

• If the interest rate on a particular account is subject to change, as is the case with credit cards that have introductory rates, be sure to consider this. Your priorities may need to change when the rates change.

• When prioritizing by interest rates, use the effective interest rate, the rate that takes into account any tax deduction. This is usually applicable to mortgages or student loans. Since interest payments on these loans are tax-deductible, the cost of such loans is actually a bit less than the stated interest rate. Calculate the effective rate by multiplying the stated interest rate by 1 minus your income tax bracket. For example, if you're in the 30 percent tax bracket and you have a mortgage with a stated rate of 10 percent, the effective interest rate is 7.0 percent (10 * (1 - 0.30))

3. Determine what strategy you need. If you're living comfortably and securely, your goal should be to prioritize your debts so as to pay them off as quickly as possible. If you're just barely scraping by, however, you should prioritize to make sure you have the necessities now while trying to minimize potential problems down the road. Each situation requires a different ordering of your priorities.

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