If you have debt and are looking to start paying it off, then you need to evaluate where to put your money first. For those with a couple of loans, this process may only require a piece of notebook paper. But for most of us with a variety of loans and debts, create a spreadsheet to compare the variances between them. These differences will help you decide which loans need to be paid off first.
Start by lining up all your sources of debt. Common types include:
*Mortgage
*Home Equity Loans
*Lines of Credit
*Credit Cards
*Student Loans
*Automotive Loans
*Specialty Loans on a luxury item such as RV, boat, or engagement ring
The three main factors involved in deciding which loans to pay off include:
*Principle and Interest
*Penalties or other conditions
*Type of Loan
Principle and Interest
For each of your loans, you need to review the remaining principle and the exact interest. To compare apples to apples, contrast the interest rate on a yearly basis.
Ideally you want to pay off the highest interest rate loans first. But you will also need to consider other factors as well. Of the highest interest rate loans, also look at the remaining balance. For example: If you pay 20% on a $100 balance, but 18% on a $1000 balance, the yearly interest expense for the $100 is only $20 while the $1000 charges is $180. Your goal should be to pay off the loans that are costing you the most to keep.
Penalties and Other Conditions
Some loans charge you a penalty if you pay them off early. In this case, if it is one of your high interest/high principle loans you can still cut the principle down without completely paying it off. This will avoid the payoff penalty, but also cut back the yearly cost of the loan.
Loan contracts can be tricky and complicated. So, if you are trying to pay off a loan balance, it is always worth your time to call the creditor. They can ensure your extra payments actually go towards paying down the principle and make you aware of any special conditions.
Type of Loan
The reason you borrowed the money in the first place can also impact your payoff decisions. Some loans save or cost you money in ways that aren’t always obvious. A great example is a mortgage. The interest you pay each year on your home loan can be a tax write-off; thus saving you some money. In contrast, a car loan can require you to carry more expensive insurance, so the additional premium cost must be considered when paying off the loan. These types of scenarios should be part of your debt evaluation.
Buying down your debt is not always a cut-and-dry discussion. It is important to evaluate your entire financial picture to be sure the money you do spend to eliminate debts is spent wisely.
Related Articles:
*Making a Plan to get out of Debt
*Adding It All Up–How Much Debt Do You Really Have?