Paying Off Personal Loans – Dos and Don’ts

There are a number of ways to get out of debt. An infinite number of ways. And there might be just as many articles, books, formulas, steps, tools, etc. to help walk you through the process of getting out of debt. So, what gives? How do I know what the best method is, and which debt I should pay off first?

There’s no easy answer to that question, but we’ve rounded up a few articles we’ve written in the past explaining options for digging out of debt or improving your credit score.

Aside from that, a good rule of thumb is to make sure you’re keeping tabs on the terms of your loans including balances due and interest rates. Also, is there a due date? Here’s a rundown of the different types of debt and how soon you should aim to pay these loans off. In general, the higher the interest rate, the better your chance of saving money is when you pay that loan off first.

Credit Cards

Generally speaking, credit card debt is the shortest term loan you’ll have. If you utilize credit cards to make purchases or pay bills, you may be doing so to take advantage of points programs or cash back opportunities. It’s a great way to save a little money or get a few perks, but the key to making sure you’re not actually hurting yourself in the end is to make sure you’re paying off a credit card balance in full each month. Credit cards come with higher rates of interest than many other types of loans, and are an easy way to find yourself deep in debt. Use this type of credit wisely!

If you do need to utilize a credit card in an emergency, and are not able to pay the bill in full at the end of the month, make sure you’re paying the minimum each month.

Auto Loans

After credit cards, auto loans are the shortest term option for getting a loan. Terms vary, but the most average length of an auto loan is about five years, or 60 months. 72-month loans are also gaining in popularity. When it comes to rates on an auto loan, make sure you’re shopping around to get the best rate available to you, from a reputable lender who makes it easy to make payments or get questions answered. Your primary bank is a great option because you can automate payments, which ensures you never miss a payment.

Home Loans

Home loans most commonly come in 15- and 30-year term options, making a home loan one of the longest loans you might have attributed to your credit history. The benefit to making payments over a 30-year period is that, as long as you never miss a payment, you’re contributing to your creditworthiness and trustworthiness as a borrower. This improves your credit score and your ability to get approved for other, larger amounts of credit in the future. While aiming to take on more debt isn’t a great goal to have in life, it is beneficial to know that you’re building a positive reputation with creditors and have a good chance of being approved for a larger loan in the future if you need it.

Student Loans

A hot topic these days, the current most frequently asked question we get from borrowers is what we think will happen with student loan forgiveness in the future. It remains to be seen what each administration is going to do in terms of student loans, but one thing is clear… make payments on these loans if they are due. If you have a low rate on student loans, it’s sometimes a good idea to simply keep paying the minimum to help increase your creditworthiness. Like with a home loan, a long consistent payment history can benefit your credit score more than you realize.

Personally, I paid off my student loans years ago – at a time when auto loan rates had dropped below the rate of my student loans. At one point, I was faced with the decision to pay off a loan or continue making the minimum payments and investing that small amount of money in some other option. Since deposit rates were also low at the time, investing the money didn’t make sense (it wasn’t enough to invest much and wouldn’t have gained more than what I stood to pay in interest over the life of my remaining loan). So I chose to pay off the student loans and get an auto loan. My debt ratio stayed the same because I had the same total amount borrowed, but I had improved my situation by shifting it into a loan with a lower interest rate.

You might not be facing the same situation, but if you’re faced with a decision between paying off one of two existing loans, make sure you’re paying attention to interest rates, balances and the life of the loan. If you simply have a tax refund you’d like to apply to the balance of a loan and can’t decide which to put it toward, a good rule of thumb is to pay off your lower balance loans first. If you can knock out the little debts quickly, you’ll feel a greater sense of achievement and motivation toward paying off larger loans in the future.

Maybe all of your loans have high balances. Divide that money up and apply it equally to all of your loans, or you might choose to make additional payments on your loan with the highest rate because that’s a loan that’s going to cost you more in interest over the life of the loan. There’s no wrong way, as long as you’re making consistent payments and keeping an eye on the rate environment, you’re unlikely to lose out in the end.