When paying off loans, which takes priority
If you have more than one loan and want to pay off the one which will most benefit you financially, how do you decide which one it is?
Here we offer a specific financial situation which an individual (let's call him Tom) wants to handle in the best possible way. There are three different choices Tom can consider before making his final decision.
The Financial Situation
Tom has four large loans which he is currently paying off. They all have the same interest rate. He wants to determine in which order he should pay them off to save the most in interest payments. He is currently paying $746 a month for all four loans. He is financially able to pay $600 more a month towards these loans but doesn't know whether to spread that amount evenly over the 4 loans or to put it all towards just one loan. Here is the specific information:
Loan A: $12,000
Loan B: $16,000
Loan C: $22,000
Loan D: $38,000
The interest rate on ALL four loans is fixed at 6.75%. The number of remaining payments is 197.
Here are three different scenarios Tom can consider on how best to apply the extra $600.
Scenario #1 - Apply the extra $600 to the smallest loan amount. By doing this, Tom could pay off Loan A in 1 year, 7 months. His total interest paid would be $654. He can apply the extra minimum payments to the other three loans plus roll over the additional $600.
Scenario #2 - Apply the extra $600 to the largest loan amount. If Tom did this, he could pay off Loan D in 4 years. The total interest paid on this specific loan would be $4,647.58. He would again have the extra minimum payments to apply to the other three loans as well as the extra $600.
Scenario #3 - Apply the extra $600 across all four loans equally. 4 extra payments of $150 are applied to each loan. Over the life of these loans, Tom would pay a total of $23,894 in interest payments. Using this method, the smaller loan would be paid off earlier so the additional money from those payments could be used to further reduce the other three loans. This would repeat with the next smallest loan and then the next until all four loans were fully paid off.