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WHICH LOAN SHOULD I PAY OFF FIRST?
February 4, 2016
If you are juggling several loans, and you are fortunate enough to find yourself with some extra cash, you may wonder which loan you should pay off first...
Should you pay off the loan with the higher rate of interest first, or should you pay off the loan with the lower payments first or should you strike a balance?
There is no right or wrong answer to this question. What is right for you depends on what your financial priorities are; whether it is to save interest or to get out of debt faster. Your decisions should also be based on your financial situation at the time. There are advantages and disadvantages to each of these 3 approaches and these will be explored briefly.
Paying Off the Higher Interest Rate Loan First
The major advantage to paying off higher interest rate loans first is that you will end up saving on interest costs. Since loans accrue interest over time, the longer you take to pay them off, the more interest will accrue and the more interest you will have to repay. If you are heavily indebted, and your priority is to save on interest costs, this approach may be the best approach to take. On the other hand, if you have paid down on the loan to the point where the interest portion is now significantly less than the principal portion, paying off the higher interest rate loan first may not result in significant interest savings.
Paying off the Lower Payment Loan First
The great thing about paying off lower payment loans first is that it frees you up and leaves you with one less loan payment to worry about. By doing this, you can proceed to apply those loan payment amounts to your remaining loan balances. This allows you to pay those off ahead of schedule which helps you to save interest and to also get out of debt at a faster pace. If your priority is to get out of debt faster, paying off the loan with the lower payments first may be the best approach.
A Balanced Approach
A balanced approach would mean that you would split your funds between paying off your higher interest rate loan and the loan with the lower periodic payments. With this approach, both loans would be paid off faster. However, if none of these loans are paid off immediately, you would still be indebted and may not experience any significant relief from this approach.
At the end of the day, the approach that you take depends on your priorities and on your personal financial situation at the time when you need to make the decision. If your goal is to save interest, pay off the higher interest rate loan first. If your aim is to get out of debt faster, you should pay off the loan with the lower payment first and apply the payment to your other balances until those are cleared off. If you can’t decide what is more important to you, then a balanced approach may work for you.