If you have too much debt, and are already experiencing credit problems, you will need to create a debt payment priority. That will help you determine which of several credit obligations needs to be paid first, and which you may be forced to delay if you don’t have the money to pay. And just as important, a debt payment priority will help you decide which debts should be paid off first.
There is plenty of advice out there on how to create a debt payment priority, but when you have credit problems you’ll have to think strategically. That means that you have to think in terms of preserving your ability to survive and holding on to a good credit score, while you are trying to get out of debt.
Keeping that in mind, here is my recommended debt payment priority:
Make Your House Payment First
When you’re facing multiple applications and financial resources are limited, this has to be your top priority. It’s all about securing your home base, so that you have a safe place to operate from.
In addition, the consequences of not making your house payment can be dire. If you’re renting, it’s likely that you will be evicted in a matter of weeks if you don’t make the payment. And if you are a homeowner, foreclosure proceedings can be brought in as little as 60 days in some states. And as many homeowners have discovered, if you get as much as 30 days behind on your mortgage, getting caught up is close to impossible.
There is no late payment type that will have more of a negative impact on your credit score than a late mortgage payment. One missed payment can cause your credit score to sink, making it virtually impossible for you to get a new loan anywhere, particularly with an affordable rate of interest.
For those reasons, making your house payment needs to be the top priority. We’re not talking about prioritizing paying off your mortgage, but keeping it current while you pay off smaller debts. This should be self-evident, but in an era of strategic default, it’s worth emphasizing.
Make Your Car Payment Next
It’s highly likely that you need your car in order to make a living. Sure, you need it to get around and to go to and from the places that your life requires. But most important is that you will need it to earn money. This is true whether you use your car for a business that you run, or if you use it to commute to and from an employer’s place of work.
While there may be a compelling case for paying high interest credit cards ahead of a low interest car payment, the comparison is not necessarily a valid one.
First, a car loan is a secured loan. Stop making payments on a car, and the car can be repossessed. Not only will the repossession destroy your credit and your credit score, but the loss of your car will likely put a stop to your ability to earn a living, causing you to default on all of your other obligations as well.
The repossession of a car is also a fairly quick process. Though you may be able to continue to live in your home for several months under the threat of foreclosure, the repossession of your car is likely to happen in a matter of weeks.
Paying off a car loan as soon as possible can be the right move. Not only will the payoff secure your ownership of the car, but it will eliminate what is probably your second largest payment, after your house payment.
Credit Cards – Special Handling Required
This is the area that people most focus on when they have credit problems. That’s because the credit problems themselves usually occur as a result of having too much credit card debt.
Assuming that you can pay your house payment and your car payment, how you pay your credit card debts is actually more complicated. There are at least three ways to prioritize the payment of your credit card debts, and which one you choose will depend upon your ability to make the payments, how deep you are in debt, and the likelihood of your ability to correct the situation on your own.
Pay the card with the smallest balance. This priority ignores both monthly payment and interest rate. But the reason why it might make sense is that paying off the smallest balance first is your best shot at eliminating a credit card debt entirely, and the monthly payment on it. Once that small debt is paid, you will have a little bit more room in your budget to concentrate on other debts. And if you’re going to use this method, the next debt should be your next smallest credit card debt. The idea is to build debt payoff momentum that will prepare you to tackle bigger debts later.
Pay the card with the highest interest rate. High interest rates affects your monthly payment on a credit card. For example, you may have one credit card with a 10% interest rate that requires that you make a minimum monthly payment equal to 2% of the outstanding balance on the card. But another card with a 25% interest rate may require that you make a monthly payment equal to 3% of the outstanding balance, so that the payment can accommodate a higher rate of interest. Assuming similar balances on each card, paying off the higher rate card first will improve your cash flow by eliminating the larger payment.
Pay the card with the highest monthly payment. This usually, but not always, is also the credit card with the highest interest rate. The idea of paying it off first is to eliminate your largest monthly credit card payment. Once you do, you’ll be in a better position to pay off your other credit cards.
Carefully weigh which strategy will be in your best interest.
If You’re Not Making Any Progress, Take the Next Step
Human nature being what it is, people typically wait a little bit too long before addressing debt problems. Often, that only starts when credit scores begin to drop, and you are unable to get new credit. If that describes your situation, it’s probably time to get professional help.
Credit problems tend to be self-perpetuating. The longer they go on, the worse they get. Your credit score drops, you’re unable to get new credit, then you start to become delinquent on your existing obligations. The situation will only get worse with time.
If you have tried to fix your credit problems yourself, but can’t seem to get the job done, get help from a law firm that specializes in credit solutions. Not only do they know how to deal with creditors, but they also know the laws, both at the federal level, and in your state. And it’s always better to have a third-party negotiate your debts for you rather than trying to do it yourself.