Should I Pay Off Credit Card or Loan Debt First?

How to Determine Which Debt to Pay Off First

Start by sending extra money to the debt with the highest interest rate or APR. That way, you’ll begin cutting down on the principal balance of your debt, and you’ll pay interest on a reduced amount.

Typically—though not always—interest rates on credit cards are higher than on loans. The average credit card APR as of February 2023 was 20.92%, according to Federal Reserve data; yours could be higher or lower depending on your personal credit profile when you applied. In contrast, the average personal loan interest rate in February was 11.48% on a 24-month loan. But personal loan rates can reach as high as 36%, depending on your credit, the type of loan and other factors.

There’s one exception to this rule: If you have a payday loan, it’s crucial to prioritize paying that off first, even before credit cards. Fees associated with these loans, and their short-term nature, can mean paying costs equivalent to an APR of more than 400%. Get these out of the way before turning your attention to other debts.

Benefits of Paying Off Credit Card Debt First

Here’s why it often makes the most sense to attack credit card debt as your first step:

• Strengthened credit score: When you pay down credit card debt, your credit utilization decreases. That ratio measures your credit balances compared with the amount of your credit limits. When utilization on one or all cards climbs above 30%, it can do more damage to your credit scores. Credit utilization (and your progress paying down loans) are included in a category that accounts for a hefty 30% of your FICO Score.
• Less interest to pay off: The longer you hold credit card debt, the more interest you’ll pay. Plus, unless you’re actively paying down your balance, you could be paying interest charges on interest that’s already accrued. By paying off credit cards first, you’re preventing high interest charges from piling up over time.
• Reduced temptation to spend: Paying off a credit card and taking it out of your regular financial rotation will mean you’re less likely to build up debt again. It’s usually better for your credit to avoid canceling credit accounts. But it may make sense to use the card only sparingly or for one subscription payment, for example, and plan not to add charges to it in the future.

How to Pay Off Debt

If you have several credit cards and loans, first make a list of your current balances, APRs, minimum monthly payments or installment payments and due dates. That will help you figure out how to begin your payoff journey. Here are a few paths you can take:

• Debt avalanche method: The most cost-saving payoff method is to target the credit card with the highest APR first, also known as the debt avalanche method. Using this strategy, you pay as much as you can on the highest-rate credit card or loan while you pay the minimum on the rest of your debts. Once you pay off the first account, you’ll move to the one with the next-highest rate and use the same strategy until all your accounts are paid off.
• Debt snowball method: You might prefer paying off small balances first, which is known as the debt snowball method. Doing so won’t save you as much money as paying off debts with the highest APRs first, but it can be effective if getting a series of small wins—by paying off accounts more quickly—encourages you to continue attacking debt.
• Balance transfer credit card: If you have good or excellent credit, you may qualify for a balance transfer credit card. This gives you the opportunity to move multiple credit card balances to a single card, potentially at 0% APR for a period of time. You can pay off debt interest-free if you get rid of the balance by the time your promotional period ends. If you have a remaining balance at the end of the intro period, you’ll end up paying the card’s higher standard APR on whatever is left.
• Loan refinancing: Another option available to those with good or excellent credit is refinancing. That’s when another financial institution pays off your prior loan or loans and issues you a new one at a lower interest rate. You can refinance a car loan, a mortgage or a student loan, and you’ll ideally refinance when interest rates are low to best take advantage of the potential savings. If you then also pay off the loan quickly, you’ll save even more in interest compared to your original loan.
• Debt consolidation loan: Similar to a balance transfer credit card, a debt consolidation loan allows you to roll multiple debts into a single personal loan with a fixed monthly payment. It’s used for repayment of installment loans instead of credit cards. For debt consolidation to work, the interest rate you qualify for must be lower than the average rate of your current debts, so it’s most likely to pay off if you have good credit.

Which Loans Should You Pay Off First?

Similar to the credit card payoff process, the best approach with installment loans is to focus on loans with the highest interest rates or APRs.

Personal Loans

With an average APR of 11.48% on a 24-month loan, personal loans are right in the middle in terms of interest rates; not as high as credit cards, but often higher than other types of loans, such as mortgages. Consider paying down personal loans after you’ve made progress on your credit cards, but before turning to your other loans.

Student Loans

There are two types of student loans: private loans, provided by banks or online lenders, and federal loans, provided by the federal government. Private loans are often more costly and come with fewer benefits like income-driven repayment plans or payment pauses due to large-scale disasters like COVID-19. For most borrowers, it makes sense to pay off private loans before federal loans, since you have less to lose and more potential money to save in interest.

Car Loan

In the first quarter of 2023, the average interest rate on a new car was 6.58%, according to Experian’s State of the Automotive Finance Market Report. But your rate may be higher or lower depending on when you first borrowed, your credit score at the time and other factors. Compared to a mortgage, a car loan is usually smaller and more manageable to pay off quickly.

Mortgage

As of June 2023, the average 30-year fixed mortgage rate was 6.67%, according to Freddie Mac. Mortgage rates have come down slightly from their peak late last year, but they’re still higher than they’ve been since 2007. If you bought your home since then, your rate may be low enough that paying off your mortgage should be relatively low on your debt-payoff priority list. If your rate is higher than current rates—although that’s very unlikely—you can consider refinancing.

Also, mortgages tend to be very large, long-term loans of up to 30 years, so paying this loan off fast might simply be unrealistic compared with paying off other, smaller installment loans over a shorter time period.

The Bottom Line

The biggest and most important step is deciding to put your attention toward debt payoff in the first place. Once you’ve gotten there, keep it simple by focusing on your balances with the highest interest rates first, which will generally be credit cards. The same interest rate strategy applies when you’re determining the best order in which to pay off your loans.

Since this approach helps you save money on interest, you’ll be able to free up cash to put toward other debts—and financial goals even beyond debt paydown. While you work on paying down your debts, be sure to monitor your credit and keep an eye out for the benefits in your credit scores.