Which Debt Should You Pay Off First?
Paying off debt as fast as possible sounds like an obvious win. It can mean less interest, fewer repayments, and more of your money left for you.
But once there's a mortgage in the picture, maybe an investment loan, a car loan, and some money sitting in an offset, it stops being that simple. The smartest move isn't always throwing every spare dollar at the balance.
Which debt you go after first changes what the whole thing costs you. So does the timeframe you go after it over. And some of it might be worth keeping.
In general, start by paying extra towards the debt costing you the most after tax, while making the minimum repayments on everything else. But interest rate isn’t the only factor. Tax deductibility, the remaining loan term and whether you’re more likely to stick with a snowball or avalanche strategy can all change the answer.
I recently unpacked this on the Financial Autonomy podcast. If you’d rather listen, you can play the episode below. Otherwise, here’s how I’d think through it.
Listen: Should You Pay Off Your Mortgage and Other Debts as Fast as Possible?
Which debt should I pay off first?
If your goal is to pay the least interest, start by working out which debt is actually costing you the most.
That sounds like I’m saying find the highest interest rate. Usually that’s a good place to start, but there’s an important catch.
If you have investment debt and the interest is tax deductible, its real cost may be lower than the headline rate suggests. Interest on your home mortgage, on the other hand, generally isn’t deductible.
So an investment loan with a slightly higher rate could still be cheaper to hold than your home loan once tax is taken into account.
Then look at the term of each debt. A high-rate loan that will be gone in two years is a very different proposition to debt that could hang around for another 25.
The rate matters. How long you carry the debt matters too.
Is it better to pay off small debt or large debt first?
This is the snowball versus avalanche question, and the honest answer is that they’re solving different problems.
The avalanche method is about the maths: pay off the highest-interest debt first and you’ll generally pay less interest overall. The snowball method is about motivation: clear the smallest balance first, get an early win, and use that momentum to keep going.
Which works better can come down to your money personality. Some people are motivated by knowing they’re following the most financially efficient path. Others need to see progress quickly or they lose steam.
And that matters, because paying down debt isn’t a one-off decision. It can be a multi-year habit. The strategy that saves you the most money on paper doesn’t save you anything if you abandon it eight months in.
So the mathematically best strategy and the strategy that works best for you won’t always be the same. Knowing what motivates you, and building your plan around it, isn’t a weakness. It’s part of making the plan actually work.
Is debt consolidation a good idea?
It can be, but this is where you need to watch the loan term.
Say you have a personal loan with a relatively high interest rate and decide to roll it into your mortgage.
The new rate could be dramatically lower.
Great.
But if that personal loan had three years left and it’s now sitting inside a mortgage you’ll be paying for another 25 years, you may end up paying considerably more interest overall.
The interest rate went down. The total cost went up.
That’s the debt consolidation trap.
If you consolidate shorter-term debt into your mortgage, one way to avoid it is to keep making roughly the same repayment you were making before. That way, you can benefit from the lower rate without allowing the debt to hang around for decades.
This is why I’m wary of judging a loan purely by its interest rate. You need to look at the whole repayment.
Should I use an offset account or make extra repayments?
Both can reduce the amount of mortgage interest you pay.
The practical difference is access to your money.
Extra repayments reduce your loan balance. Depending on the loan, you may be able to access some of that money later through redraw.
Money in an offset stays in a separate account while reducing the balance on which your lender calculates interest.
That can make an offset particularly handy for money you want to keep available anyway.
Your emergency savings could sit there. So could your bills money or cash you’re putting aside for a holiday or renovation.
Instead of having that money sitting elsewhere while you pay interest on the full mortgage balance, it can be doing some work for you in the meantime.
Just make sure you compare the overall cost of the loan, including any fees or rate differences attached to the offset facility.
Should I pay off my home loan or investment loan first?
This is one of the areas where the obvious answer can be wrong.
Imagine your investment loan has a slightly higher interest rate than your home loan.
You might naturally attack the investment loan first.
But if that interest is deductible and your home-loan interest isn’t, the investment loan could have the lower after-tax cost.
I ran some numbers for a client in the original podcast episode who had borrowed to invest in shares. Once we allowed for the tax deduction and the income produced by the investments, the amount of growth required for the strategy to remain viable was considerably lower than we initially expected.
That doesn’t mean investment debt should always be kept.
It means I’d want to understand what the debt is actually costing you and what you’re getting in return before deciding where to put a large lump sum or years of extra repayments.
Your tax circumstances matter here, so this is an area to check with your accountant before changing anything.
Should I pay off my mortgage as fast as possible?
For some people, absolutely.
Owning your home outright can reduce your expenses, give you security and free up a significant amount of cash flow.
But I don’t think zero debt needs to be the goal at any cost.
If you have spare money, the decision might be between paying extra off the mortgage, adding to super, investing outside super, building up your offset or paying down another loan.
That’s a different question from How fast can I get this mortgage to zero?
It’s really:
Where will my next dollar have the greatest impact?
And once you have investments, super, tax considerations and several financial goals competing for that dollar, a generic rule can only take you so far.
So what is the best way to pay off debt?
Start by getting clear on what each debt is actually costing you.
Look at the interest rate, the remaining term, whether the interest may be deductible and whether refinancing or consolidating would genuinely reduce the total cost.
Then think about what you’re trying to achieve beyond simply seeing a smaller debt balance.
Sometimes the best move will be paying a loan off aggressively.
Sometimes it will be making better use of your offset.
And sometimes keeping relatively low-cost debt while directing your money somewhere else may make more sense.
Want a Financial Plan That Uses Debt Strategically?
Once you have a mortgage, investments, super and other financial goals, the question isn’t always how fast you can get rid of debt. It’s how debt should fit into the bigger plan.
At Guidance Financial Services, we can help you work out which debts to prioritise, where your spare cash could have the greatest impact, and whether keeping some debt could support what you’re trying to achieve.
This article is for educational purposes only and does not take into account your individual circumstances. If you would like tailored advice, we can help you work through the numbers properly.
