1

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.

  • Yes, you must be miscalculating, but we can’t tell what you’ve done wrong unless you show your full workings. – Mike Scott Dec 8 '18 at 8:18
  • Once loan B is paid off, you put its $40 payment toward the other loan. Every single month. – Ben Voigt Dec 8 '18 at 23:33
3

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.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.