How to Efficiently Pay Off Your Debt

Americans have a debt problem. The average American household has $90,336 in debt. ($5,517 of this is credit card debt, $7,871 is from auto loans, $9,153 from student loans, and $60,700 from mortgages). The average borrower owes 155% more than what they think they owe.

We also have a math problem. The average credit card interest rate is 17.55%. The average savings account interest rate is 0.06%. The expected return in the stock market is, depending on what time period you measure by, between 7% and 10%. Your credit card debt is costing you far more than your savings are earning you.

In addition to saving you money and giving you more cash flow and freedom to do what you want with your money, getting out of debt can help relieve stress and anxiety in your life. 

Let’s take a look at the numbers and figure out the most efficient way to pay off your debt.

Credit Cards

First, make sure you are paying at least the minimum on every card before doing anything else. Failure to make payments can cost you, both in penalties and in hits to your credit score.

Empty Out Your Savings Account

After that, the most efficient way to pay off your credit card debt is to empty out your savings account.

You heard me.

Money is money is money. You have a positive balance in your savings account earning you 0.06%. You have a negative balance in your credit card account costing you 17.55%. Every month that you keep a spare $1,000 in your savings account rather than paying down your credit card, you are throwing away money.

The most common push-back to this position is: “But what if I have an emergency? Don’t I need an emergency fund?”

And the answer is: probably not right now. You absolutely should build an emergency fund. But your credit card debt is a much bigger problem right now. If you have an emergency and need to spend money, you can put it on the credit card. It will feel like a step backwards seeing your credit card balance go up after you’ve been paying it down, but it will still save you in interest over keeping cash lying around just in case. Plus, you will be paying down your highest interest rate cards first, and you should put any emergencies on your lowest interest card to maximize the amount you save on interest.

That said, personal finance is personal. Our goal here is to maximize happiness, not necessarily maximize wealth. If going under a certain number in your bank account will cause you anxiety and stress, then don’t go below that number. Just recognize that you are paying a price for that comfort. If it is worth it to you, then go for it.

Pay Down the Highest Interest Rate Card First

There are two schools of thought with regards to which cards to pay down first. One school has the mathematical advantage and the other has a psychological advantage. I’m in the math camp, because I find that if you understand how the psychology works, you can prevent your brain from getting duped into being sub-optimal and costing you money.

Pay the highest interest rate card down first. Make the minimum payment on every card each month, and then throw all of the extra money you have at the highest interest rate card. Once that is paid off, move on to the second highest. Rinse and repeat.

By paying off the highest interest rates first, you are minimizing the amount of interest that you pay overall.

The other method is Dave Ramsey’s debt snowball method. Dave tells his readers and listeners to pay off the lowest balance first, regardless of the interest rate. The idea behind this is that you will feel like you are making progress when you pay off a card in full, and this will give you the motivation to keep going.

I’m not big on the idea of wasting money for no reason, so I would recommend getting your motivation elsewhere (like recognizing that your debt is an emergency! ). If you need the short-term psychological boost of seeing a bill disappear, then go with Ramsey’s method, but I recommend at least trying the highest interest rate method first. I know that I would rather be sure that I am getting out of debt faster and cheaper. But as always (say it with me, kids): personal finance is personal.

Other Options

Balance transfers can be a good option for people with large amounts of credit card debt, but make sure you read the fine print.

Watch out for “0% interest for X months.” The rate will often jump from 0% to an exorbitant number at the end of that period and they will often retroactively charge you interest for the whole 0% period if you fail to pay the card off before the end of the 0% interest period. Read the terms and conditions and make sure you pay the card off before the 0% period is over! Throw some notifications into your calendar to remind you of upcoming card deadlines.

Also, watch out for balance transfer fees. Most cards that offer a 0% interest period for transfers will charge you a transfer fee. Do the math! Figure out how much the transfer will actually cost you and figure out whether that is higher or lower than the interest you would save by leaving the balance on your old card.

Peer to peer lending is another option. Prosper and Lending Club will allow you to move your credit card debt into a peer to peer loan (if your credit score is high enough). This will often be a lower rate than the credit card. Follow the same advice as above. Check for loan origination fees and compare the amount you spend to transfer the debt to the amount you would save in interest.

Student Loans

As a law school graduate, I have a little bit of experience with student loans. Okay, I have a lot of experience with student loans.

Step one is to look into repayment programs that make sense for your situation. For example, if you are a teacher or a public servant with a lot of loans, check out the Public Service Loan Forgiveness program. The PSLF program will calculate how much you owe each month based on your take home pay and will forgive any remaining debt at the end of ten years.

I am using this program for my quite substantial law school loans. I work in a rewarding and fulfilling public sector job. That job pays significantly less than an equivalent private sector job. To help make up for this difference my loan payments are based on my income and any unpaid balances at the end of ten years will be forgiven.

Note, though, that programs like this are only available for federal student loans, not private loans. If you have private loans, talk to the servicer about whether they have any programs available that you could use.

If your loans are at a high interest rate, you may want to consider consolidating them at a lower rate through a service like SoFi. Be aware that if you move your loans from a federal servicer to the private sector you will lose access to any of the government repayment programs. Also, be sure to run the same analysis that we discussed above regarding balance transfers of credit cards to be sure that the move will actually save you money.

If you have multiple loans, treat the repayment process like the credit cards above. Make the minimum payments on all of the loans and then throw as much extra money as you can at the loan with the highest interest rate.

There is a lot of debate as to whether it makes sense to pay off student loans as quickly as possible. Here’s my take:

First, definitely get rid of any higher interest loans. The rule of thumb is that you should definitely pay off any loans at 5% interest or higher. The expected rate of return if you were to put your money in the stock market is higher than 5%, but paying off the loans is a guaranteed 5%, where there is risk in the market.

After that we get back to the “personal” aspect of personal finance. As a numbers guy and an optimizer, I would continue making minimum payments on any loans under 5% while investing the extra money in the stock market.

The key here is that you need to actually invest the difference! If you are putting the extra savings in a savings account or, worse, spending it on frivolous things(!), then you are paying interest without seeing any potential gain. This is a waste of money. Either invest any extra money or get rid of the debt.

Some people want to get rid of their lower interest student loan debts before investing because they hate the feeling of having debt. They don’t like having the extra monthly payment. They don’t like feeling like someone has something over them.

I respect that. If you’re one of those people, then go ahead and get those loans paid off as soon as possible. As discussed above, however, just remember that you are paying a fee to get that extra peace of mind.


Whether to pay off your mortgage as quickly as possible is significantly more hotly debated than the same issue with student loans. Nevertheless, my rule is the same: pay it down or refinance if it is over 5% and keep it around and invest the difference if it is under 5%.

One argument for keeping the mortgage around is that you get to deduct your mortgage interest on your tax return. However, this does not negate the fact that you are paying interest.

First, the home mortgage deduction can only be taken if you itemize your deductions. If you are taking the standard deduction and paying mortgage interest, then you are SOL.

Second, the tax deduction doesn’t deduct the full cost of interest. It only deducts a portion of your interest based on your marginal tax rate.

If your marginal rate (the tax rate that you are paying on your last dollar) is 25%, then you get a tax deduction of 25% of the mortgage interest that you paid. Arguing that you should keep the mortgage payment around no matter what is like arguing that you should spend $100 just so you can get $25 back. You are still wasting $75.

The same caveats that apply to student loan repayment apply to mortgage repayment. Make sure you are actually investing the difference between what you could pay and what you are paying. If that money is sitting in a savings account, then you should just pay down the mortgage because you are wasting your shot at potential upside. If you are a person that is uncomfortable with debt, then go ahead and pay down the mortgage recognizing that you are paying a fee for peace of mind.

As I have noted quite a few times: personal finance is personal. (Are you sick of hearing that yet? Are you even still reading this far down?) But make sure you know the numbers and are making informed choices rather than blindly following whatever debt repayment methods feel right.

Anything I missed?  Any follow up questions?  Any misdirected Internet rage?  Hit me up in the comments.

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