Which loan should you pay off first?

Times are changing and with it has changed our outlook towards life. Unlike the earlier generations, we no longer wait for our retirement benefits to own a house or buy a car.

Cost of living has gone up tremendously and we need more money to keep things moving.

Be it buying the objects of desire, funding higher education or owning a house, we are increasingly getting dependent on loans.

But loans can prove to be double-edged sword. If loans help us in meeting our big-ticket requirements, excessive debt burden can also drain out our resources.

Thus, it is important to know how many loans to avail and how to pay them off. You should prioritise your repayments to come out of the debt trap in a systematic manner. Things may be easier if you have a single loan but it could be tricky if you have multiple liabilities.

How to prioritise?

There are two types of loans – secured and unsecured. In secured loans such as home or auto loan, the lender provides loan against collateral and can take possession of the house or car in case of a default.

However, there is no collateral in unsecured loans and thus the interest rates are very high.

You should look into interest rates that you are paying across the loans and start paying off the costliest one first. Prepare a list of all loans and find out where your outgo is the highest. Here is a list of what should be your priorities in descending order:

Priority #1: Credit card loan

Outstanding credit card dues can be your biggest tormentor as interest rates on rollover can go up to 35-40 per cent. If the outstanding amount is too high, you can get it converted to a personal loan to be paid in 6-12 EMIs. This new loan comes at an interest rate of about 15% which is still lower than that charged on rollover.

Priority #2: Personal loan

Personal loans are unsecured and thus come at a high interest rate varying between 18% and 25%. Personal loan EMI may form a major chunk of your monthly outgo. Though personal loan repayment is a costly affair, it is still advisable to put off the burden as early as possible.

Priority #3: Car loan and other loans without benefits

Car loan, gold loan or other loans taken against insurance policy, PF or property do not come with any tax benefits and should be paid off keeping in view the rate of interest payable.

Priority #4: Student loan

Higher education and professional courses have become very expensive and it is not possible for the middle-class to afford it without a loan. However, you should not be in a hurry to prepay it as you can enjoy tax benefit on interest payments. As you can offset interest with the tax benefit, you should concentrate on high interest loans first.

Priority #5: Home loan

Given the tax benefits and size of the home loan, it should figure last on your priority list. You can avail tax benefits on both the principal as well as interest. Moreover, the exit route in a home loan is also different.

Before you decide to pay off a loan, you should not overlook the investment opportunities as sometimes the latter may be more lucrative. Instead of paying off loan, you can invest your money if it can yield more than the interest you are paying on your loan.