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How to Determine Which Loan to Pay off First

which loans to pay off firstBeing in debt can really make things in your life seem so uneasy. No one wants to wake up every day constantly thinking about debt, which is something many people think about, unfortunately. When you want to get out of debt, how do you decide which loan to pay off first? Use this guide to come up with a strategy that works for you.

How to Determine Which Loan to Pay off First

80 percent of American workers live paycheck to paycheck. This means that many people are relying on personal loans to meet their financial obligations.

If you’re anything like most people in the U.S., you have a couple of loans you’re already paying off. Having multiple loans can take a toll on your finances, so it’s prudent to create a plan on how to pay them off.

But which loan should you prioritize?

Continue reading to know how to determine which loan to pay off first.

Related: 7 Reasons to Pay Your Student Loans Off Fast

Extremely High-Interest Loans Go First

A high-interest rate makes a loan expensive.

Let’s say you have 3 loans, as follows:

  • $10,000 credit card, 25% annual interest
  • $10,000 personal bank loan, 5% annual interest
  • $100,000 mortgage, 4% percent annual interest.

Every month, you’ll find that the credit card is taking away most of your money because of the high-interest rate. If you don’t want to lose more money than necessary, pay off your high-interest loans first. This will usually be unsecured loans, such as credit cards, payday loans, and merchant cash advances.

Prioritizing high-interest loans means making the minimum monthly payment on all the other loans, and a higher payment on the high-interest loan.

Related: Types of Loans to Consider Before Turning to Payday Loans

Low Balance Loans Come Next

Paying off debt is often a psychological struggle. You’re always thinking of the day you’ll finally pay off your loans and be debt-free. You want the taste of freedom so bad.

In this case, you want to see that you’re making progress. If even one loan can be removed from your list of debts, you’ll experience a big sigh of relief.

You can make this happen by giving priority to the loan with the lowest balance. As in the case above, you’ll make minimum monthly payments on all your other loans, and a higher payment on the loan with the smallest balance.

As soon as you pay it off, you’ll happily tick the debt off your list. This will give you the motivation you need to keep repaying your other loans.

After this milestone, you can even consider consolidating all the remaining loans. This enables you to get a loan, which you’ll use to pay off those loans. The result? You’ll have just one credit line on your list, possibly with a lower interest rate.

Related: How the Debt Snowball REALLY Works

The Need to Boost Your Credit Score

The need to boost a bad credit score can affect how you prioritize paying off your loans.

Credit cards have a big impact on your credit score. If you consume your entire limit, your credit utilization ratio will skyrocket, negatively affecting your credit score.

So, if your goal is to build your credit score (perhaps you want to qualify for a mortgage), you will have to pay off your credit debt first.

Now You Know Which Loan to Pay Off First

Loans aren’t necessarily a bad thing. But when you have a couple of loans, paying them off can present a big challenge. Knowing which loan to pay off first can make a big difference to your finances and quest to be debt-free.

Need more tips and hacks? Keep reading our blog for more great stuff!!

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AUTHOR LaTia Longuemire

My name is LaTia Longuemire. I enjoy writing, singing, and cooking in my spare time. My passion is helping others. At this stage in my lifetime, I'm primarily focused on my children. They are everything that keeps my world spinning.

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