Which Loan Should I Pay off First?

Sometimes people have to have things they can’t immediately afford in life. For example, high school students who go off to college rarely have the money they need to pay off school; families who are buying homes rarely have the means to purchase a house outright; and therefore, loans are a necessary part of life! However, repaying loans is never an easy feat, but deciding which loan to repay first can put you in the right direction.

Principal Is Key

Almost all loans gain interest overtime, but the amount of interest that a loan gains is entirely dependent on the principal (the amount the lender gives to the recipient.) For example, a credit card loan may have an insane interest rate (some cards have over a 20% yearly interest rate), but other loans can have an insanely high principal. For example, say someone has a credit card that has a 20% interest rate and a $300. When calculating for the year, the total interest for this card would be $60.

However, a loan from the government for a school bill may have an annual interest rate of 4.25%, which seems small in comparison to the interest rate of the credit card, but the loan principal is $20,000! Therefore, after a year of no repayments, the loan would garner $850.

As you can see, bigger principal loans typically garner more interest than bigger interest rate loans with small principals. However, a medium sized credit card debt can quickly take over other loans as the first repayment target. A credit card debt of $5,000 can gain interest at a rate of $1,000 a year! So despite the principal of the credit card debt being a fourth of the loan debt, the interest would be higher than the school’s.

As a general rule of thumb, any loan that has a medium-high amount of principal is probably the loan that needs to be repaid the soonest.

If you need help with planning out your financial future, contact us now for a free quote!