9.3 Prioritizing Debts and Avoiding High-Interest Loans

Effectively prioritizing your debts is key to managing your financial situation, especially when resources are limited. Not all debt is equal—high-interest debts like credit cards and payday loans can quickly spiral out of control, making it harder to achieve financial stability. By focusing on the debts that cost you the most and avoiding the trap of high-interest loans, you can take control of your financial health and work toward becoming debt-free. Here’s how to prioritize your debts and make informed borrowing decisions.

Focus on High-Interest Debt First

High-interest debts, such as credit card balances and payday loans, should be your top priority because they accrue interest more quickly than lower-interest debts, costing you more money over time. The faster you pay off these high-interest debts, the less you’ll pay in interest, which can save you significant amounts in the long run.

  • Tackle Credit Card Debt:
    Credit cards typically have higher interest rates than other types of debt. By focusing on paying down credit card balances first, you’ll save the most money on interest. Even paying a little more than the minimum each month can speed up the repayment process and reduce the amount of interest you’ll pay over time.
    • Example: Sophia’s Credit Card Focus – Sophia had three debts: $2,000 on a credit card at 18% interest, $5,000 in student loans at 5% interest, and $1,500 on a car loan at 4%. She prioritized her credit card debt first to stop it from accruing high interest, which saved her hundreds of dollars over the repayment period.
  • Avoid Payday Loans and Cash Advances:
    Payday loans and cash advances often come with extremely high interest rates, sometimes exceeding 400% APR. These types of loans can create a debt trap, making it almost impossible to pay off the principal due to compounding interest and fees. If you already have payday loans, prioritize paying them off as quickly as possible to avoid falling deeper into debt.
    • Example: Tom’s Payday Loan Challenge – Tom took out a payday loan with a 300% interest rate. Realizing how quickly the interest was adding up, he made it his priority to pay off the loan immediately, even if it meant cutting back on other expenses for a few months.

Consider the Impact on Your Credit Score

If maintaining or improving your credit score is important to you, it’s essential to understand how different types of debt affect your credit. Prioritize paying off debts that directly impact your credit score, such as credit cards, loans, and revolving lines of credit.

  • Focus on Revolving Credit:
    Credit cards are a type of revolving credit, and carrying high balances can negatively affect your credit utilization ratio, which is a key factor in your credit score. Prioritizing credit card debt can improve your credit utilization and, in turn, boost your credit score.
    • Example: Emily’s Credit Strategy – Emily had multiple debts but decided to focus on her credit card balance first because it was affecting her credit utilization ratio. By paying down her credit card, her credit score improved, which helped her secure better loan terms for future financial goals.
  • Pay Attention to Installment Loans:
    Debts like student loans, car loans, and mortgages are installment loans. While these loans affect your credit score, they usually have lower interest rates, making them a lower priority in terms of repayment. However, it’s still important to stay current on these payments to avoid negative marks on your credit report.

Avoid Taking On New High-Interest Debt

Resist the temptation to take on new debt, especially if it involves high-interest loans. Borrowing more money when you’re already in debt can make it much harder to get ahead. This is particularly true for payday loans, cash advances, and high-interest personal loans, which can quickly spiral into unmanageable debt.

  • Avoid Payday Loans and Cash Advances:
    Payday loans often charge exorbitant interest rates, sometimes in the triple digits, making it nearly impossible to pay off the principal amount. If you’re considering a payday loan, explore other options first, such as borrowing from family or friends, seeking community assistance, or negotiating payment plans with creditors.
    • Example: Carlos’s Decision to Avoid Cash Advances – Carlos was tempted to take out a cash advance to cover an unexpected medical expense, but after researching the high fees and interest rates, he chose to borrow from a low-interest personal loan instead.
  • Explore Alternatives Before Borrowing:
    If you need to borrow, look for alternatives to high-interest loans. Personal loans with lower interest rates, borrowing from a credit union, or using a balance transfer credit card with a 0% introductory APR can be more manageable options for short-term borrowing.
    • Example: Sophia’s Balance Transfer Card – Instead of taking out a high-interest personal loan to cover her debt, Sophia applied for a balance transfer credit card with a 0% introductory APR for 18 months. This allowed her to transfer her high-interest debt to the new card and avoid paying interest for the first year and a half.

Explore Lower-Interest Borrowing Options

If borrowing is necessary, always seek out the lowest-interest options available to you. Lower-interest loans, like personal loans from a bank or credit union, can provide more manageable repayment terms than payday loans or credit cards.

  • Consider Personal Loans:
    Personal loans typically have lower interest rates than credit cards or payday loans and come with fixed repayment schedules, which make it easier to plan for regular payments. However, be sure to compare rates and terms before committing to a personal loan.
  • Balance Transfer Cards:
    Balance transfer cards often offer 0% introductory APRs for a set period (e.g., 12–18 months). This allows you to transfer high-interest debt to the new card and avoid paying interest for a limited time. Just be sure to pay off the balance before the introductory period ends to avoid higher interest rates afterward.
    • Example: Emily’s Balance Transfer Strategy – Emily transferred her $3,000 credit card debt to a balance transfer card with a 0% APR for 12 months. She used this interest-free period to pay down the balance without accumulating additional interest.

Communicate with Creditors

If you’re struggling to make payments, don’t wait for the situation to worsen—contact your creditors as soon as possible to discuss your options. Many creditors are willing to work with you by offering hardship programs, reduced interest rates, or extended payment plans, especially if you’re proactive about communicating with them.

  • Request Hardship Assistance:
    Many lenders offer hardship programs that can temporarily reduce or suspend your payments, lower your interest rates, or extend your repayment terms if you’re facing financial difficulties.
    • Example: Tom’s Hardship Program – Tom lost his job and knew he wouldn’t be able to make his credit card payment. He called his credit card issuer, and they offered a hardship program that reduced his interest rate for six months, allowing him to make smaller payments without accruing as much interest.
  • Negotiate Payment Plans:
    If you’re unable to make your current payments, ask your creditor if they can offer a more affordable repayment plan. Negotiating a new payment schedule can help you avoid late fees and keep your account in good standing.

Action Step: Prioritize Your Debts

To start prioritizing your debts and avoid high-interest loans, follow these steps:

  1. Review Your Debt List:
    Make a list of all your debts, noting the interest rates, minimum payments, and due dates for each. This will help you see which debts are costing you the most and which ones should be paid off first.
  2. Choose a Repayment Focus:
    Prioritize high-interest debt, like credit cards and payday loans, as they accumulate interest more quickly. Use the debt snowball or debt avalanche method to organize your repayment plan.
  3. Avoid High-Interest Loans:
    Resist the temptation to take out new high-interest loans. Instead, explore lower-interest alternatives if borrowing is necessary.
  4. Communicate with Creditors:
    If you’re struggling with payments, contact your creditors to discuss hardship options or negotiate a more manageable payment plan.

Conclusion

Prioritizing your debts and avoiding high-interest loans are essential steps toward achieving financial freedom. By focusing on high-interest debt, considering the impact on your credit score, and avoiding new debt, you can regain control over your finances. Exploring lower-interest options and communicating with creditors when needed can help you stay on track and build a more stable financial future.

Reflection Questions:

  1. Which of your debts carry the highest interest rates, and how can you prioritize paying them off?
  2. Are there any opportunities to consolidate or transfer high-interest debt to a lower-interest option?
  3. How can you avoid taking on new high-interest loans and stay focused on your financial goals?