How To Prioritize Your Debts
When you are in a financial bind, it is helpful to divide your debts into essential and non-essential. An essential debt is one that will impact your health and security if service is interrupted.
Once debts are divided this way, priorities can also be established within each category according to what will hurt the most if it's not paid.
Following are some guidelines to help you determine what is essential and what is non-essential in your life:
- Debts relating to essentials for a life, include the following:
- Food. Think in terms of what is necessary, not what you've become used to. The equivalent of a lobster dinner is not essential (though you may want to do one every now and again for your mental well being.)
- Necessary medical expenses, including health insurance premiums.
- Rent or mortgage. Real estate taxes can be postponed, but not for long.
- Utilities: Heat in the winter is essential. Air conditioning in the summer may or may not be. Minimum payments should keep the service running.
- Medical care if you continue to receive necessary treatment from the provider.
- Car payments if necessary for your job or health care. Do not let your car insurance lapse. It's not only against the law in some states, but you risk what you have left plus future income.
- Child support has to be paid or you risk going to jail.
- Unpaid taxes. Rather than risk having the IRS take your paycheck or other property, work out a repayment plan. You have a right to get a repayment plan if you owe less than $10,000 and you have never defaulted on an agreement with the IRS.
Debt that should objectively considered to be essential. For example:
- Whether or not the debt is backed by collateral: Will you lose something tangible (like furniture) if you don't pay the debt? If so, is what you would lose something you could do without? How would this affect your family's health and security?
- The amount of equity you have in something: If you are paying off a car that's currently worth $15,000 and you owe only $2,000, you probably don't want to risk losing it. On the other hand, if you owe $4,500 on a deep-freezer worth $5,000 you won't be losing as much financially if you stopped making payments and it's repossessed.
Prioritize non-essential debts by the rate of interest, impact on your credit rating and other consequences.
- The rate of interest you pay on the debt: All else being equal, you'll want to pay your higher-interest debts off first. You'll pay less interest in the long run. If you're not in danger of losing personal property or real estate, keeping interest to a minimum may be your top consideration.
- Impact on your credit rating: Poor handling of student loans is reported to credit bureaus, but being behind on student loans may not damage your credit rating as much as poor management of other debt such as credit cards, automobile loans, or a mortgage.
- Other consequences: For example:
- Student loans are subject to special collection remedies, including special wage garnishment (taking of your wages.)
- At the other extreme, if you owe money to friends and family, they are likely to understand and not push for debt repayment if you tell them about your health and financial situation.
- Debt that has an emotional kick when you get the bill each month.