I got an email from my little sister the other day asking a question that gets asked quite often…
“Which debt should I pay off first?”
In most situations I recommend Dave Ramsey’s Debt Snowball method of paying off the debts from smallest to largest, starting with the lowest balance first. The reason being that many people need the “small victory” of getting a debt paid off to help keep them motivated.
In this particular case, I suggested something different.
Question
Ok, so we want to pay off the last of our debt (not including our house) and I’m trying to figure out which one we should be aiming to pay off first…
Student Loan
- 6.625% interest rate
- Balance of around $7,500
- I pay $100 each month
Car Loan
- 5.84% interest rate
- Balance of around $9,500
- I pay $300 each month
I have heard you should pay off the one with the highest interest rate first, but I’ve also heard that student loans are ‘good debt’, so I’m not sure what to do…
My Answer
1. The car loan is a collateralized loan, so if you can’t make the payments they will take your car. If you can’t pay your student loan, they can’t take anything from you (in most situations).
2. The balances in each are pretty close, so they are both going to take a decent chunk of change (and or time) to get them paid off. That being the case, when you get the car loan paid off you will have $300 extra to spend each month to pay down the other debt as opposed to the student loan which will only free up an extra $100 each month.
3. Student loans are pretty easy to defer or get forbearance – so if you lose your job, medical emergency, etc you can work out a deal and avoid making payments until things stabilize a bit. Your car lender would probably laugh in your face if you asked to defer payments.
Any other opinions about which debt to pay off first?
{ 12 comments… read them below or add one }
I vote for the car as well. It can be so easy to get underwater on a car loan, and it’s MUCH easier to sell a car if you own it outright. If you still have a loan on it, it’s such a headache.
I believe if you can’t pay your student loans, they can garnish your wages (though I’m not certain).
Once that car loan is gone, that extra $300 freed up could really help teh student loan go away even faster.
Student loans, to an extent, are deductible so I also vote car!
The bulk of her extra money should go to paying off her car debt, but she may want to consider raising the amount she pays to her student loan.
I would add another $50-$100 to the student loan debt, then focus the rest on the car debt if her budget allows. If she’s only paying $100 on her student loan, she must be paying a high amount to the interest, not the principle, each month.
definitely the car. its a depreciating asset so the longer you own it, the less it is worth and the less wise your interest payments on the car will be. the student loan debt is definitely not depreciating, and while the interest rate is higher, the need to own the car outright far outweighs the temporary higher interest cost of the student loan.
I know it’s heresy to criticize anything Dave Ramsey says, but the debt snowball solves more problems than it creates. It’s the equivalent of spending a few bucks going to the dentist to get a crown put on, while ignoring your collapsed lung.
The car loan is bigger, and you’re paying it down faster anyway. Deal with it first.
Get the student loan deferred (unless income is too high to make that possible) – use the extra $100 to accelerate the car payoff.
Car for sure … without even seeing the details of the loans was my initial feeling and then when I read through your post fully I couldn’t help but agree even more!
I agree with others that the car loan should be the first to go!
Once that is gone more can go to the student loan or the funds can be used for other things if you are in a cash flow crunch.
Just an aside about car loans, when I lost a job once I did call Ford credit and they gave me a one month reprieve on my loan, just adding the payment to the end w/out other penalties. Maybe not possible in every case, but worth a shot to call in advance of being late.
A few things:
First most student loans are government backed federally funded. Basically means they do have a few options like hardship deferral that are benefits but also being federal debt are 100% non bankruptable. They may allow you to slide for short periods of time but they will collect over any other lender out there and have the means to garnish and take any means to collect.
Whereas a car loan, yes it is collateralized and if you don’t pay they will come take the car, but who cares. Can you not go rebuy a car when you are ina better situation and are I don’t know able to actually afford one. Our society thinks the wrong way about so many things. Like buying high priced cars, financing depreciating assets and then wondering why there net worth hasn’t moved in five years.
Put giving and saving first and try building a nest egg! Sometimes just hearing people answer questions like these makes me realize how very few people even focus on the right question?
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In a way, your answer does follow the debt snowball. The key is usually to pay off the smaller debt first, in this case, you’re paying off the one that will go away quickest. If you assume your sister makes no extra payments, she’ll be done with the car loan in 35 months, the student loan in 98 months. But, if she finishes paying off the car, then puts the extra $300 on the student loan, she will have it paid for in 49 months. Completely debt free in a little over 4 years!!
I think even Dave Ramsey would agree with you
Bob is right, pay the most important one to be paid off and try really hard to pay other debts so that you can live life with less or no debts. That is an amazing and relaxing life.