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Are You Paying Off the Wrong Debt?

Posted January 13th, 2010
by Staff

Some statistics suggest that consumers are paying off a record amount of debt right now. While on the surface that may sound like a good thing, it may not be the case. In part, the reason debt is being paid off may have more to do with banks tightening their controls than it does families deciding that they want to get out from under debt.

Unfortunately, some consumers are paying off “good” debt such as low-interest personal loans, and wind up having to rely on debt with higher rates, such as credit card debts. Personal loan rates may be as low as six percent or lower, while credit card rates can be much higher, at an average of right around 18 percent.

Now, before we go any further, it’s worth noting that paying off debt isn’t a bad thing in and of itself. If you can pay off a six percent personal loan without having to borrow other money from somewhere else, that’s a good thing. The problem comes when people pay off lower interest debt and then wind up taking higher interest debt later on.

If you’re in a position to pay off debt, you need to be smart about how you do it. In general, there is an order you should pay off debt:

  1. Payday loans. If you have payday loans, you should pay them off as soon as possible. These loans are convenient and helpful, but they come at a hefty price. Renewing a payday loan can incur sizable fees.
  2. “Store” credit cards. A JC Penney credit card or a Best Buy credit card is a major convenience. In some cases, you even earn rewards when you use these types of cards. If you’re able to pay off debt, though, these should be next to go. They tend to have relatively high interest rates.
  3. Other credit cards. As noted, credit cards have an average rate of about 18 percent, which is much higher than other types of credit. Pay these off next.
  4. Personal loans, first unsecured then secured. Unsecured personal loans tend to have a much higher rate than secured ones, so pay those off first.
  5. Car loans. Your car loan probably has a much better rate than most of your other loans, so it should be one of the last things you pay off.
  6. Home loans. Home loans tend to have the lowest rates of all. If you have a second mortgage, it may have a higher rate than the first mortgage, so start there.
Categories: Advice



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