“No man’s credit is as good as his money.”
E.W. Howe
The reco from Experian, who rates you and your credit: “the general recommendation is to focus on the debts with the highest interest rates.” Sounds easy, am I right. Nope.
You should consider other uses of that money, your own ongoing expenses and what you’re planning to spend in the future. These all matter. Here are the most common loans, and ideas on the debts to pay off first.
Student loan
Payment plans, deferments, and forbearances could let you readjust payments and put your time and earnings towards higher interest payments. Even with those options, you need to pay your student loans and failure to do so will hurt your credit score, like your credit card debt. Similarly, student loans play into your debt to income ratio, late payments will kneecap your score and defaults take you out entirely.
On the other hand, student loans boost your credit mix, factor into the length of your credit history, and, as an installment loan it doesn’t hurt you in the way revolving credit does. Basically, “credit card debt has a larger influence” on your credit score than your student debt.
When it comes to interest, you’re paying off the interest on your student loan debt which is typically less than a standard investment return. You’ll essentially make more while taking as much time as possible to pay your loan. If you’re young, you’re compounding your investment at the most critical time in your life. Furthermore, so many payment plans exist for student loans that will allow you to minimize and stretch payments while meeting government requirements. Student debt is not the most important to pay off first, nor the least important to pay off last. It’s somewhere in the middle, and despite #Cancelstudentloans, you’ll still have to pay at an ongoing clip like other debts.
Mortgage
Owning a home has long been the American dream. Paying off your mortgage and owning it free and clear has been portrayed as nirvana. The pinnacle of financial achievements.
Not so fast. It could actually be advantageous not to pay off your mortgage. Here are a few reasons:
- Interest rates have been historically low in the past few years. While they may tick up, you still will likely pay less in interest than other loans and your credit cards.
- As mentioned above, interest rates are also likely ticking up. If you invested the money you would have used to pay off your mortgage early, then you could potentially make even more in the market. This is especially true if you’re older and can really maximize the contributions to your IRA or 401-k.
- You have more cash on hand, which is a good thing for any personal needs and in the eyes of banks and other lenders.
- It may cost more to borrow against your paid off mortgage. Lenders look at many components of your credit score and financial position. Your mortgage payment history could be beneficial and remain cheaper to borrow against rather than a paid-off home equity loan.
Check out more at Consumer Reports on the Disadvantages of Paying Off Your Mortgage.
Car loan
Owning your car free and clear could feel amazing. Perhaps you have a four year payment plan on a car that will go another ten years. That’s a decade of cruising free and clear!
However, like everything else, there are drawbacks to paying off your auto loan early.
Some companies charge a prepayment penalty. The lender will penalize you because they “won’t reap as much interest from your loan.” That might tell you everything you need to know.
Also, as mentioned above, you could use that extra money to pay down a loan with a higher interest rate, or put it into the market or your retirement account.
Personal loan
First, make sure there isn’t a prepayment penalty.
Next, check your interest rate and determine if that extra money can be better leveraged by paying down a loan with a higher interest rate. You could also use the money to invest in the market or through your retirement account. By doing this, you might make more money in the long term.
Finally, consider that paying off your personal loan counts as a closed account on your credit score. Yes, you’ve paid off your debts. However, your credit score might be higher if you have an open account that you always pay on time. It’s a tricky little bit that you should take into account.
Final Note: It’s not easy to get out of debt. It will require determination, dedication and conversation with your partner. Stay focused and stay inspired on getting there. If you do this strategically, it will all be worth it.
