Not all debts are created equal. If you're carrying a lot of different kinds of debt, it's important to figure out which ones should be your highest priority to pay off and which can hang around a little longer. It's especially important to prioritize your debts if you're struggling to keep up with your payments. If you must fall behind on one or more of your debts, you'll need to choose which ones to delay based on the potential consequences, not on which collections agent is screaming at you the loudest.
An important debt distinction
For starters, it's important to understand the difference between secured debt and unsecured debt. Secured debt is money you've borrowed while using something you own as collateral. When you take out a secured loan, you're making a promise to the lender that if you don't make your payments, the lender can have the collateral instead. For example, a car loan is usually secured by your car. If you don't make your payments, the lender can take your car away, no matter how much of the car you've paid off.
On the other hand, unsecured debt is debt that's not based on any collateral. Credit card debt is usually unsecured debt, although if you have poor credit a bank may ask you to put some money in a special account as collateral before they'll open an account for you (not surprisingly, these credit cards are known as secured cards).
If you've reached a point where you have to skip a payment on something, secured debt is typically a higher priority to pay than unsecured debt, because you stand to lose more if you can't pay the debt. If you end up in collections on a credit card account, the credit card company can't come and take away your house or your car, but if you miss a few payments on a secured debt, that could very well happen.
All that said, secured debt generally carries a lower interest rate than unsecured debt because the lenders have your collateral as backup in case you don't repay them, and they're willing to sacrifice some interest for that security. So if you're not struggling to keep up with your debt load, paying down unsecured debt first makes good financial sense.
The debt that's most important to keep on paying is debt that would have horrible, earthshaking consequences on you if you defaulted. Ironically, these are the creditors who are least likely to hound you with collections calls and letters, because they know they don't have to: You have such a powerful incentive to keep paying them that they know it's unlikely you'd stop.
High-priority debts include:
- Housing payments (both rent and mortgage).
- Car payments, assuming you have only one car that you rely on to get around.
- Child support. Setting aside the fact that your kids live on this money, you could end up in jail if you fall behind on your payments.
- Utility bills. Just imagine living without water or power for a few months.
- Unpaid taxes. Even bankruptcy won't save you from tax debt.
- Any debt that's secured by something you can't live without.
The consequences of not paying these debts are serious, but not quite as dire as the consequences of skipping out on high-priority debts. Medium-priority debts include:
- Insurance payment. In some cases this may be a high-priority debt -- for example, if you're in poor health and your life is dependent on medical care.
- Federal student loans. The government can get pretty nasty about these, going so far as to garnish your wages or take money straight out of your income tax refund.
- Secured debts that don't fall into the high-priority range, like the car loan on a second car, or debt secured by property that you don't rely on heavily.
Except in special circumstances, the remaining types of debt are not quite as important. If you have to fall behind on something, it's fairly safe to fall behind on low-priority debt. However, you can still expect some unpleasant consequences even for defaulting on these debts. For example, it can take years to repair your credit after a series of negative reports from creditors.
Low-priority debt typically includes:
- Credit card debt.
- Internet and phone bills unless they're necessary for you to do your job.
- Memberships and subscriptions.
- Loans from people you know (hopefully Uncle Joe will understand that you need more time before you can pay him back).
- Other unsecured debts.
Dealing with the fallout
Any time you fall behind or default on debt, there will be consequences. At the very least, you'll have to deal with some extremely nasty phone calls and a hit to your credit report. So as soon as you possibly can, go back to making at least the minimum payments on all of your debt. You might also consider credit counseling and debt management programs, although it's wise to vet such programs carefully first; the debt management industry is full of rip-off artists and second-rate services. Finally, bankruptcy is a last resort that will have major repercussions on your future, but it can get you free of overwhelming debt when there's no other way out.