Owing money to people can be a dangerous game. Sure, there are times where taking out debt in order to make more money can be beneficial. But sometimes that can backfire. Especially when you owe that money to a family member or a close friend. So if you find yourself in that boat, let me show you when to pay off family debt. And more specifically, where it falls in the order of paying off debt.
The Order to Pay Off Debt
I don’t like debt. Yes, there is a time and place to have it. And there is a time and place where debt may not be avoidable.
After all, most people do not have the money or the means to pay for college outright.
And even fewer people have enough money to purchase a house outright.
Even vehicles can be prohibitively expensive a lot of the time.
The problem is when we justify taking out debt for items that are simply too expensive for our income. We often stretch ourselves unnecessarily to purchase items that we cannot truly afford.
And I’ve done it too.
So if you find yourself in a place where you want to start paying off that debt (including when to pay off family debt), here is the order in which you should pay off your debt.
- Tax debt
- Family debt
- High interest debt*
- Low interest debt*
- Your mortgage
Here is the caveat though.
High interest debt means different things to different people.
If you are in your 20s, consider high interest debt as being anything above 7%.
If you are in your 30s, consider high interest debt as being anything above 6%
If you are in your 40s, consider high interest debt as being anything above 5%.
And if you are in your 50s, then you want to start paying off all of your debt so that you can go into retirement debt free. But do so in order of interest rate (highest to lowest).
The reason for the decreasing interest rate as you get older is because when you are younger, your money is more powerful because it has a longer time to grow if it were invested. As you get older, that power starts to decrease.
Why You Should Pay Off Family Debt Fast
The reason that tax debt is at the top of the list in order of paying off debt is because the IRS has basically unlimited power.
They can garnish your wages, file judgements, or even throw you in prison for not paying your taxes.
But the reason that I believe that you should pay off family debt next is a bit of a hot take. But an important one nonetheless since about 31% of people owe family members money.
In my opinion, you should pay off family debt ASAP. Similar to that of tax debt.
If you have both tax debt AND family debt, pay off the tax debt first. Because Uncle Rico probably won’t throw you in prison for not paying him back but the IRS will
Most family debt is interest free. I get that. But in my opinion, owing money to family members or close friends money can make things uncomfortable. Especially if you fall behind on the payments or life hits you and you are struggling.
Just pay off the money owed to family members and close friends ASAP, even if there is no interest that is being accrued.
If you find yourself struggling to pay off your family members just let them know.
I have done it myself. I borrowed money from two of my grandparents and fell behind on the payments.
Both times, I did not let them know what was going on and it put a real strain on our relationship for a while.
Don’t do that.
Do better than me.
Most people understand that tough times happen and things happen. Just let them know what is going on and they are much more likely to be understanding than if you were to simply ghost them.
Final Thoughts
When to pay off family debt is a topic that I think gets ignored too often in the world of personal finance. We often get too focused on rates of returns, APRs, and behavioral finance to remember that there are real people to consider with real relationships with family members and close friends.
If you owe family members money, just pay it off. After the IRS of course.
You can do it!
I am here for you!
Until next time!
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