Clearing debt, and the order to do it in

Investing is not the first thing anyone should do with spare money, and any guide that skips straight to it is doing you a disservice. For most people with expensive debt, clearing it is the highest-returning thing available — and unlike an investment, the return is guaranteed.

This guide is about how debt behaves, and about the two orders you can pay it off in.

If debt is already unmanageable — missed payments, borrowing to cover borrowing, or the sums simply not working — the right next step is free, regulated debt advice rather than a strategy guide. In the UK, MoneyHelper is government-backed and free, and will point you at properly regulated help. That is a better use of the next hour than anything below.

The true cost of debt

Compounding is the same mechanism whichever direction it runs. On savings it works quietly in your favour for years. On debt it works quietly against you, with one important difference: the rate is usually far higher, and it is contractual rather than hopeful.

That last point is the one worth sitting with. An investment might return something in the region of a few per cent above inflation over a long period, and might not. A debt charging a high rate is costing you that rate, every year, with certainty. Paying it down is not merely a good return — it is a guaranteed one, and nothing in investing offers that word.

Which produces the only genuinely uncontroversial rule in personal finance: if a debt costs more than you could reasonably expect to earn by investing, clearing it wins. The arithmetic is not close, and it does not require anyone to predict anything.

The other cost does not show up in a rate at all. Debt reduces your options — the job you cannot leave, the risk you cannot take, the bad month that becomes a crisis rather than an inconvenience. People who clear expensive debt consistently describe the relief as disproportionate to the money involved, which suggests the money was never the whole cost.

Good debt and bad debt

The distinction is real but it is usually drawn in the wrong place. It is not about respectability, and it is not fixed per category. It comes down to two questions: what rate is it charging, and does the thing it bought produce anything?

• Debt that bought an asset or an income — a home you would otherwise be paying rent on, training that raises what you can earn — has something on the other side of it. It can still be a bad idea if the rate is high or the sums do not work, but it is at least a trade.
• Debt that bought consumption — a holiday, a car beyond what you needed, last year's spending — has nothing on the other side. You are paying interest on something already used up.
• Debt at a very high rate is bad regardless of what it bought. A rate high enough compounds faster than almost anything can outrun, which is what makes revolving credit balances so difficult to escape.

A useful test that cuts through the categories: would you borrow at this rate, today, to buy this thing again? If the answer is obviously not, that debt has moved to the front of the queue whatever it is called.

The credit game

Credit scoring is treated as mysterious and is mostly mechanical. The details differ between agencies and lenders, and no one outside them knows the exact weightings, but the broad shape is not secret.

• Paying on time, every time, is the largest single factor almost everywhere. Not paying a lot — paying on schedule.
• How much of your available credit you are using matters, and lower is generally read as healthier. Someone using a small fraction of their limit reads differently from someone at the ceiling, even at the same balance.
• Length of history helps, which is why closing an old account can occasionally be counterproductive.
• Frequent applications in a short window tend to read as distress, whatever the reason actually was.

Two things worth knowing. First, your score is not one number — different agencies hold different data and lenders apply their own criteria on top, so the figure an app shows you is an indication rather than a verdict. Second, the score is a means, not an end. It exists to get you better rates on borrowing you actually need. Optimising it for its own sake is a hobby, not a financial plan.

Minimum payments are designed to last

Before choosing an order, it helps to see why doing nothing in particular is so costly, because the minimum payment is not a neutral default. It is a number the lender chose.

On revolving credit the minimum is typically set as a small percentage of the outstanding balance, with a floor. Two consequences follow. First, most of an early payment goes to interest rather than the balance, so progress is slow in a way that is not obvious from the statement. Second, because the payment shrinks as the balance shrinks, the schedule stretches out ahead of you as you go — paying the minimum on a meaningful balance can take a very long time and cost more in interest than the original purchases.

This is why the single most valuable habit here is not choosing the clever order. It is fixing your payment at an amount and refusing to let it fall as the balance does. A payment that stays flat while the balance drops is the same mechanism as the snowball, applied to one debt.

Clear the debt, then keep the habit

The part that gets skipped, and the reason some people clear the same debt twice.

When the last balance goes, a sum of money that was committed every month suddenly is not. If nothing is decided, it is absorbed within a couple of months by the same lifestyle drift that operates on a pay rise, and the position you fought for becomes the new normal with nothing to show for it.

The alternative takes one decision, made before the final payment rather than after: that money keeps moving on the same day it always did, into a buffer first and then into whatever comes next. You have already proved you can live without it — you have been living without it for however long the repayment took.

That buffer matters more than it sounds, because it is what stops the cycle restarting. Most debt is not incurred through recklessness. It is incurred because something broke and there was nothing else available.

The snowball: smallest balance first

Pay the minimum on everything, then aim everything spare at the smallest balance regardless of its rate. When it clears, roll that entire payment onto the next smallest, and so on. The amount going at debts grows each time one falls, which is where the name comes from.

On pure arithmetic this is not the cheapest order, and its defenders do not claim it is. The argument is about completion: clearing a whole debt early is a visible, definite win, and it arrives soon enough to be motivating. A plan you keep going with beats a cheaper one you abandon in month four.

That is not a soft argument. The most expensive repayment strategy is the one that gets abandoned, and every pound of theoretical interest saved is worth nothing if the plan does not survive contact with a difficult month.

The avalanche: highest rate first

Cover the minimums, then direct every spare pound at the highest-rate debt regardless of its size. When it clears, move to the next highest.

This is mathematically optimal. It always costs less in total interest and always finishes sooner, because you are attacking the fastest-growing balance first. If the numbers were the only consideration, there would be nothing to discuss.

Its weakness is motivational rather than mathematical. If your highest-rate debt is also your largest, the first visible win can be a very long way off, and a plan with no feedback for a year is a plan under strain.

Which to use

The honest answer is that the gap between them is usually smaller than people expect, and both are enormously better than paying minimums.

• Where the rates are similar, use the snowball. You give up almost nothing and gain the momentum.
• Where one debt is at a punishing rate, use the avalanche. When one balance is compounding much faster than the rest, the arithmetic stops being a rounding difference.
• Where you have tried and stalled before, weight it toward whichever gives you a win in the first couple of months — usually the snowball. History is data about what you will actually stick to.

The choice matters far less than the two things both methods share: paying more than the minimum, and not adding new balances while you do it.

The buffer that stops it happening again

One structural point, because it determines whether any of this holds.

A repayment plan with no buffer behind it is a plan that survives until the first unexpected bill. The boiler, the car, the reduced hours — and with nothing set aside, the only available response is the credit that was being paid down. The plan does not fail because of the plan. It fails because there was no slack in it.

Which produces an order that looks wrong on a spreadsheet and works in practice: a small buffer first, then the debt, then a larger buffer. The first buffer is deliberately modest — enough to absorb an ordinary surprise, not enough to make a real dent in the repayment — and it exists purely so that one bad week does not undo six good months.

Strictly, every pound in that buffer is a pound not reducing an expensive balance, and a spreadsheet will tell you so. The spreadsheet is not modelling the thing that actually goes wrong, which is not arithmetic but interruption.

Ask for a better rate

The most overlooked move is also the fastest, and people skip it because it feels presumptuous. Lenders would generally rather keep a paying customer at a lower rate than lose one, and rates are more often negotiable than the paperwork implies.

It costs one phone call. Know what you currently pay, know what is being advertised elsewhere, ask plainly whether the rate can be reduced, and be willing to say you are considering moving. The realistic outcomes are a reduction, an offer of something else, or a no — and a no leaves you exactly where you started.

A rate reduction is worth more than it looks, because it compounds for the entire remaining life of the debt, and it required no additional money at all.

None of this is clever. It is arithmetic and one uncomfortable phone call, which between them beat most of what gets written about money.