It’s a sad fact of modern life that unless we are diligent we are bound to end up with a multitude of debts, so it’s no wonder that people often feel overwhelmed when considering which debt they should pay off first.
This topic is usually centered around credit card debt and often pits philosophies and formulae against one another. For example, many people espouse the Dave Ramsey snow-ball method, while others decry it as too simplistic.
What this post isn’t about.
This post is not about the snow-ball or any other method of repayment. This isn’t about the nitty gritty of how to weigh various balance amounts and interest rates against each other to arrive at the optimum payoff order of your credit card balances. In fact, this isn’t even about any specific type of debt.
What this post is about is how you should go about classifying your debt and which category of debt should be paid first and why.
Naturally the best course of action is to keep your debt to a minimum, if you can’t avoid it all together. But to help you get there sooner, consider this list of importance when paying off your debt.
#1. IRS debt.
IRS debt is the most important to pay off, hands down. You simply don’t mess with Uncle Sam. If you fail to pay your taxes, the government can garnish your wages and seize your home and property. If you find yourself owing the IRS back taxes, you can go the tax relief route to help clean up your mess but it’s best to avoid the situation altogether.
#2. Credit card debt & personal loans.
Credit cards and personal loans carry the worst interest rates and fees. The longer you carry debt of this type, the longer you will be working for things you bought in the past and the longer you will wait until you have the freedom of your paycheck back. It’s that simple.
#3. Car loans.
Auto loans get us to what is known in the industry as secured debt, sometimes called “good debt.” The reason is that there are often tax deductions associated with it, and the terms are more favorable because there is something that could be repossessed if you fail to pay. While you don’t get to deduction the interest on your car loan, you will typically see a lower rate than on credit cards.
#4. Student loans.
Student loans are typically the lowest interest rate you can get, and if they’re not you can usually use a student loan consolidation company to lower your interest rates significantly. Besides, most graduates end up paying their student loans until they retire anyway. 
#5. Mortgage.
Mortgage debt is about the best debt you can have. Don’t confuse that with a mortgage being a good thing. Most people would like to own their home “free and clear” if given the option, just for peace of mind. But there are arguments that say a mortgage is a good thing to have. I’m not personally so interested in that thought because I don’t know very many people who simply do not have the luxury of paying off their mortgage in less than a decade, and that’s with serious stick-to-it-ivness. Most homeowners will have a mortgage and while it may not be the best thing in the world, it’s far from the worst. You get to deduct the interest payments on your taxes, and it allows you to buy a much nicer house than you would likely be able to afford without one. The trick is finding the happy medium and what works for you.
The importance of order.
That’s assuming you are paying off each of those debt obligations. Interestingly, if you are looking at a situation in which you cannot afford to pay all of your creditors and you might end up defaulting on the obligation, the order is a bit different.
In the case where you have to pick and choose which category of debt gets paid and which does not, the order of importance looks more like this:
- #1. IRS Debt.
The IRS can garnish your wages and seize your property. You could even do jail time if your situation is serious enough.
- #2. Mortgage.
Don’t pay your mortgage, and you lose your home and all the money you spent on it over the time you owned it. That’s a serious hardship and setback. It also does very bad things to your credit score.
- #3. Student loans.
The interest rate is usually more favorable than other forms of debt, but failure to pay your student loans at all will lead to having your wages garnished and being hit with serious fees.
- #4. Car loans.
Failure to pay your auto loan will result in your car being repossessed. This is bad for your credit score as well as your freedom of mobility.
- #5. Credit card debt & personal loans.
Failure to pay your credit card and personal loans can lead to a lot of lost money in interest charges and fees, as well as ruining your credit score but there’s no loss of property and a small chance of having your wages garnished.
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