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Most resources seem to indicate that you want to pay down loans in order of decreasing interest rate. However, I did some manual calculations and found I should be paying down the loans based on the size of their interest (not the interest rate). Am I miscalculating something?

For example, I have loan A for $3,500 at 4.66% and loan B for $1,300 at 5.00%. Both loans have a minimum payment of $40. Below is the amortization schedule for the first 20 months or so.

         Loan A         |     Loan B
 #  Remaining  Interest   Remaining  Interest
01  $3,500.00   $13.59      $1,300.00   $5.42
02  $3,473.59   $13.49      $1,265.42   $5.27
03  $3,447.08   $13.39      $1,230.69   $5.13
04  $3,420.47   $13.28      $1,195.82   $4.98
05  $3,393.75   $13.18      $1,160.80   $4.84
06  $3,366.93   $13.07      $1,125.64   $4.69
07  $3,340.00   $12.97      $1,090.33   $4.54
08  $3,312.97   $12.87      $1,054.87   $4.40
09  $3,285.84   $12.76      $1,019.26   $4.25
10  $3,258.60   $12.65      $  983.51   $4.10
11  $3,231.25   $12.55      $  947.61   $3.95
12  $3,203.80   $12.44      $  911.56   $3.80
13  $3,176.24   $12.33      $  875.36   $3.65
14  $3,148.58   $12.23      $  839.00   $3.50
15  $3,120.80   $12.12      $  802.50   $3.34
16  $3,092.92   $12.01      $  765.84   $3.19
17  $3,064.93   $11.90      $  729.03   $3.04
18  $3,036.84   $11.79      $  692.07   $2.88
19  $3,008.63   $11.68      $  654.96   $2.73
20  $2,980.31   $11.57      $  617.68   $2.57
    ....

If I make an extra payment of $500 to loan A, I reduce the principal to $3,000. I've essentially skipped the first 18 payments and thus I've saved about $228.63 in interest payments.

For loan B, the same $500 would skip about 14 payments, totaling $62.50 in interest. Because of the low balance, most of my payment was already going towards the principal.

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  • Yes, you must be miscalculating, but we can’t tell what you’ve done wrong unless you show your full workings.
    – Mike Scott
    Commented Dec 8, 2018 at 8:18
  • 1
    Once loan B is paid off, you put its $40 payment toward the other loan. Every single month.
    – Ben Voigt
    Commented Dec 8, 2018 at 23:33

1 Answer 1

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Your problem is that you are using a different duration for the two loans, so of course paying off part of the shorter-term loan produces a smaller benefit if you don't put the money you are saving towards reducing the other debt. If you didn't put the $500 towards either loan, you would be paying $80 per month for 35 months and then $40 per month for a further 73 months. If you put the $500 towards the higher-interest loan and keep the same repayment schedule, so paying $80 per month towards the longer-duration lower-interest loan for 14 months after the other loan is paid off early, you will pay less in total than if you put the $500 towards the lower-interest loan.

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