Which one?

[gallan]

I need some help deciding how I should pay off my loans. I have two personal loans:

1. Balance of $1050, monthly payment of $50, 0% interest for the life of the loan.
2. Balance of $15,300, monthly payment of $295, 10.5% fixed interest rate

Both loans have fixed monthly payments. Neither loan has a prepayment penalty. I'm unable to refinance/consolidate either of the loans at this time. I'm currently making $600 payments on the big loan.

I recently sold my car and now have about $9000 in the bank. Here's my question. Should I put all $9000 towards the big loan or should I pay off the small loan and put $8000 towards the big loan? I was originally just going to put all $9000 towards the big one since the small one has a 0% interest rate and I feel like it would be a waste. But then I thought, if I pay off the small one, I could still put $8000 towards the big one, but then I'd also get back that $50 a month that I could then put towards the big one as well. Make sense?

So what should I do? Is it worth it to pay off the small one and put that extra monthly payment towards the big one? Thanks in advance for any advice.

Full disclosure: I have no savings either, and have considered putting some of it into a savings account. But I feel bad having savings while I'm still in debt, because the savings account won't have an interest rate anywhere close to that of my debt.

[disneysteve]

You should not totally deplete your savings now that you have some. Keep at least $1,000 and maybe up to $2,000 in your account as a buffer for unforeseen expenses.

Since the 0% loan is fixed (not a promo rate that expires), I'd be in no hurry to pay it off. Just keep paying the minimum and focus your attention on the other loan. 10.5% is ridiculous. Get rid of that as fast as you can. Put $8,000 of your savings toward it now and knock it down to $7,300. Keep making the $600/month payments and it will be gone in about a year. Then in 2 more months, you can knock out the 0% loan if you'd like.

[ActYourWage]

I would save $1000 dollars and pay the $1050 loan off today, and pay the reminder $6950 on the bigger loan. That way you can have a small psychological victory of paying off a debt, then you can attack the bigger debt like there is no tomorrow.

Something to keep in mind is personal finances are more psychologoical than mathematical, or we all would be debt free (living below our means). When one sees progress being made, the more likely they will succeed.

[krantcents]

Since you have no savings, I enough in your savings to cover 2-3 months expenses. I would pay down the large loan withe remainder. Pay off the big loan as fast reasonably possible.

[jpg7n16]

do you have a new mode of transportation?

whatever you do, don't pay off the 0% loan.


It's like you have two apartments: one is charging you 10.5%/year to live there, and the other is giving you free rent.

Why would you ever rush out of the free rent place??

Move your stuff out of the expensive one first, and keep the rent free place as long as they'll let you.

[ActYourWage]

gallan,

I thought I would run the numbers on your situation to see how it adds up.

Note: These figures are all approx. given your provided information.

Savings: $9,000
  Debts:$15,300 10.5%
        $ 1,050  0.0%

Save $1,000 for an emergency fund. That leaves you with $8,000.

Here is what you are looking at if you pay off your smallest debt today:

Debt Amt   Savings Pmt   Balance  / monthly pmt  Time Frame
$1,050   - $1,050        = $0     / $0	       Today
$15,300  - $6,950        = $8,350 / $650         12.846 months 

for a total of 12.846 months before being debt free.

(note: the $650 is the added $50 you were paying on the smaller loan and now applying it to the larger loan)

Here is paying largest debt first:

Debt Amt   Savings Pmt   Balance  / monthly pmt  Time Frame
$15,300  - $8,000        = $7,300 / $600         12.166 months
$1,050   - $0            = $1,050 / $50	     12.166 months 

(balance after 12.166 months)
$441.70                  = $441.70 / $441.70       .679 months (got this number by dividing the current balance of $441.70 by the current monthly payment of $650)

for a total of 12.845 months before being debt free.

Given the numbers you provided and if my numbers are correct, you could technically (by a thousandth of a point:)) pay of the larger debt faster than paying the smaller debt first in this particular situation.

The point is which ever way you choose, stick to the plan.

[uRabbit]

While the general consensus is to pay off the highest interest loan/credit line first, I have realized that paying something off gives me more ambition to pay something else off. I just paid-off a Best Buy card and, while it had a lower balance and monthly payment, but a higher interest rate, all that did not matter. It was the fact that I paid it off! Now, I've got $1,200 to go on my other card, and that'll just get done faster with my extra $26/mo from my BB card.

[kork13]

you can have a small psychological victory of paying off a debt, then you can attack the bigger debt like there is no tomorrow.

A potentially valid idea for someone who is overwhelmed by their debt and feels that there is no hope. OP does not appear to be in this situation, so instead, I would recommend a financially smarter course.

I recommend that you save whatever will make you comfortable to cover a minor unexpected emergency ($1k-$3k or so, whatever works for you), then send the rest to the big loan. Forget paying off the 0% interest loan early, it's better for you (financially) to just pay it off slowly and hammer down on the large debt charging you over 10% interest. By the time you pay off the big loan (around 18 months from now), you'll be about finished with the small loan as well, just by paying the minimum on it.

I've got a large loan right now that is charging just 1% interest. I've had it for over 4 years, and I'm paying off as slowly as possible -- it won't be finished until 2013, and I've got no qualms with that at all. Even though I have the cash available that I could pay it off tomorrow if I'd like to, I'm putting the money to a much better use in my investments. In your case, put your money to the much better use of paying less in interest.

[gallan]

Thank you all for the advice! I admit that I really wanted that psychological victory of paying off the small loan, but I agree that it's just not necessary. I'm not swimming in debt and generally feel pretty well-off, despite these two loans.

After careful consideration, I'm putting $2100 into savings, and the rest towards that big loan. Thanks again!

[Frugal]

I agree that it is always a good idea to keep at least $1000 in a savings account, in case of emergency, before you pay down debt. Some people probably cannot do even that right now, but it sure can help if your car breaks down, or someone falls ill, or the house has a problem.