Here's What Happens if You Pay Off the Wrong Debt First

Being in debt can be a real drag. Not only can it wreak havoc on you mentally, but it can cost you a lot of money in interest. So if you've recently come into some money, whether in the form of a tax refund, raise, or inheritance, you may want to use it to pay off some of the debt you've accumulated.

But if you're going to tackle your debt load, it's important to go about it strategically. If you pay off the wrong debt first, you might end up costing yourself a lot of money in interest, not to mention hurting your credit score needlessly.

Interest rates really matter

You might have a variety of debts, such as a mortgage, personal loan, and credit card balance. You may be inclined to leave your mortgage alone, since it's a long-term debt, and focus on the other two first. But generally speaking, a personal loan is going to come with a lower interest rate than a credit card balance. So if you have both types of debt, you're probably best served paying off your credit card first.

Imagine you're paying 7% interest on your personal loan and 17% interest on your credit card. Even if your personal loan balance is a lot smaller than your credit card balance, and you're able to shed it in full, it doesn't make sense to pay off a debt with a lower interest rate when you owe money on a credit card that's charging you more than double.

You should also know that too much credit card debt specifically can damage your credit score. That's because a big factor that goes into calculating your credit score is your credit utilization ratio, which measures the amount of revolving credit you're using at once.

If you have a total spending limit across your credit cards of $10,000, and you owe $4,000 on one of those cards, that's 40% utilization. But a ratio above 30% could be detrimental to your credit score, so that's yet another reason to tackle your credit card debt first.

Map out a plan

You may be eager to shed all of your debt as quickly as possible. But it pays to go about the process methodically.

Tempting as it may be to tackle smaller loan balances first, from a financial standpoint, your best bet is to really focus on interest rates instead. Order your debts from highest interest rate to lowest, and then work your way down that list.

And if you're eager to get rid of your debt as quickly as possible, don't just apply a windfall to your debt when a pile of money lands in your lap. Instead, make lifestyle changes that allow you to free up cash consistently. That could mean cutting your spending on non-essential items and getting a second job to boost your income.

Having debt hanging over your head can be a terrible feeling. So the sooner you're able to get rid of it, the better you might feel about your financial picture.