Which Loan Should You Pay Off First?

Kolkata November 23: There are times when we have to take a loan to meet various requirements. Taking a loan is not a bad thing. For example, it would not be possible for most of us to buy a car or a house without a loan. However, when one takes a loan one needs to make regular payments to repay the loan. Failing to do so can cause a lot of problems from affecting one’s credit score to creating bigger financial trouble going ahead.

Paying off a loan is a good feeling as that means one has fewer financial commitments. However, sometimes when we have several loans to pay off, the debt burden might seem too much. In such cases one has to take a strategic approach to pay off the debt.

Owning money is not a good thing, especially when you have problems paying it back. One needs to understand that there are broadly two kinds of debts - good and bad debts.

Home loans, car loans and educational loans are generally considered as good debts. On the other hand, loans like personal loans and credit card debt is considered as bad debt. Any other type of loan, whether it is an EMI purchase, salary advance loans and so on are all bad debt.

When you have too much debt to pay off, it is first important to have a debt repayment plan. The first step is to list down the following.

1. Type of loan ( home loan, car loan, personal loan and so on)

2. The amount of loan and the amount that is to be repaid

3. The interest rate for each loan

4. The tenure

There are several strategies one may now employ to tackle this debt. One way is to pay off the bigger loans first. However, the strategy that is the most recommended is to pay off high interest debt first. For example, if you have paid the minimum balance on your credit card you would be paying interest of up to 45 per cent per annum. If you have such debt you should pay it off first. Next comes personal loans that can have an interest rate as high as 20 per cent. However, even as you pay off these debts, it is important to keep in mind that you cannot default on your regular monthly payments on your good loans. But if you have any extra cash you can spare, it is first advisable to pay off high interest debt and not the one with the maximum EMI outgo. For example, you would have a higher EMI on your home loan, but you should pay off your personal loan first.

However, certain loans come with prepayment charges. Take that into consideration before making any loan payments before time. Finally, if you are already under a lot of debt, try getting into more debt. Always follow the thumb rule- your total EMI payments should never exceed 35-40 per cent of your income.