Which Should I Pay Off First: My Debt or Personal Loan?

Dear Kristin,

Should I pay off debt, or pay off a personal loan? 

Sincerely,

Maureen

Dear Maureen,

I applaud you for looking at your debt and taking steps to pay it off. It can seem like an overwhelming, or even impossible, task. But with some tools and tips, you can do it!

Paying off debt is an especially relevant question during times when the Federal Reserve raises interest rates because borrowing money and having debt gets more expensive. The higher the Fed hikes rates, the more you’ll have to pay in interest when you take out a mortgage or car loan, and your credit card interest rate could go up, too.

So which debt should you pay off first? It depends. Personally, I like to pay off whatever debt has the highest interest rate. This is known as the debt avalanche strategy. For example, if you have an interest rate of 4% on a car loan, but carry a balance on a credit card with an interest rate over 20%, you may be better off chipping away at that credit card debt because, in the long run, you’ll save more money by paying less in interest. Of course, you should keep paying the minimum on that car loan so you don’t default, but any extra money can go toward that credit card balance.

You could also try the debt snowball method, where you pay off your smallest debts first before moving on to larger ones, regardless of interest rates. This can be a motivating strategy for those who enjoy seeing debt disappear. For example, as you pay off a small $500 credit card balance, you may feel more motivated to tackle that $10,000 personal loan.

You haven’t mentioned what kind of debt you have, or what kind of personal loan you’ve taken out. Is it a loan from a friend or family member with no interest rate at all, or is it from a bank or lender? Is your debt from spending on credit cards, or do you have a mortgage? The answers to these questions will help you determine which of your debts you should repay first.

And while I mention that paying off debt in order of interest rate is a good approach, it might not be the best strategy depending on the type of debt you have. For example, if you have secured debt (which is backed by collateral) and you have fallen behind on the payments, it would be best to catch up on those payments so you don’t lose the asset tied to the debt. Let’s say you’re behind on your mortgage payments—not only can that harm your credit score, but it can also put you at risk of losing your home. You should catch up on those payments before tackling your other high interest rate debt. 

But perhaps all of your debt is unsecured, so you’re not worried about losing an asset. If one of those debts is causing you greater stress, you might find that paying off that debt first is best. For instance, if you haven’t paid back a loan from a family member or friend and it’s causing damage to your relationships, it’s understandable if you want to pay them back first, even if there is no interest on the debt. 

Once you take a hard look at your debt, you can prioritize it based on the risks associated with the debt, the interest rate, and the balance. But don’t forget to take into account how you feel about some of the debt you hold. There are also ways you can better manage some of this debt, such as working with a credit counselor or even negotiating a lower payment directly with your credit card company. You may want to be wary of some debt settlement companies, as they may charge expensive fees or not be able to settle your debt at all. Budgeting tools may also help you repay your debt, and then help you stay debt-free once you eliminate it.

Whatever you do, be kind to yourself in this process. It’s not uncommon for people to have debt, so don’t feel ashamed. 

Good luck!

-Kristin

If you have questions about money, Kristin is here to help. Submit an anonymous question and she may answer it in a future column.

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