I have 9,000 cash. What debt should I pay first?

Question

I have 9,000 cash right now and I want to use it to pay some debt. It won't cover all, but I want to spend it on the best way possible. These are my current debts:

• Loan balance 3,867.35 - 23.55% interest rate 9/48 payments @ 145.59 / month
• Loan balance 3,894.20 - 19.03% interest rate 9/48 payments @ 134.62 / month
• Credit purchase balance 9,584.80 - 8.99% interest rate 6/36 payments @ 357.93 / month

At first glance it seems like I can pay almost the full bigger debt, but I think if I pay the first 2 I will save a lot on interest. On the other hand, if I pay the bigger one I have some more extra cash free per month.

Answer 1

Generally, there's no particular "win" to paying off the larger debt first, all things being equal. Pay largest interest rate first.

(Now, some advisors say there's a certain logic to paying off the smallest debt first when you only have a trickle of money to do it, irrelevant here -- the concept is to create an "emotional feeling of success" as soon as possible, to give an early reward and "give confidence" and motivation. If you need that, do it, but strictly from a rationalist financial POV, it's a waste of perfectly good money.)

First, do you have an emergency fund? Consider the different perspectives about emergency funds. Some advocate a hard 8-month fund, others say only save $1000 until debt is paid off (that speaker is particularly hard-line against debt, I don't agree). Your emergency fund is banked and not spent. It's for job-loss emergencies, not QVC emergencies. Lots of excuses though: "I'm not expecting another 2008" -- nobody expects a 2008. "Don't need it, my country has social services" -- are you sure you're eligible in every case? (e.g. US unemployment doesn't work if you're fired for cause), even so, that only shrinks the size of the necessary fund, doesn't eliminate its need. "My emergency fund is the unused credit line on my credit cards" -- which the bank will take away from you at the first sign of trouble.

Next, not all debts are equal.

• Things like student loans, tax leins, court judgments etc. stick to you for a long time and can't be discharged in bankruptcy -- however they also have the best options for deferment.
• Secured loans are attached to a car, boat, house, whatever that will be repo'd if you don't pay. If it's an important tool-of-trade, that's a good reason to prioritize it. If you live in a public transit desert like much of the USA, your car is a tool-of-trade.
• Unsecured (credit card, retail account, unsecured loans) are the lowest priority.

Then the math is real simple: Highest interest rate first. Nail the 23.5% first, then the 19%. Don't pay more than the minimums on the 9% until the others are paid.

Your logic is pay the largest first since its minimum payment is higher. Maybe -- but you'd net about $77 more per month paying it off first, but with the other hand you'd be paying 19 & 23% instead of 9% on what remains, and the lower minimum payment (which is doing you no favor!) would stretch out the loans even longer. For each $77 "obtained" this way, you'd accrue an additional $47 in interest -- making it the most expensive $77 you ever borrowed.

Some gory details:

If you pay at minimums only, and the minimum does not shrink since these are numbered payments:

The $3867 loan will cost $1651 in interest total cost $5588. The $3894 loan will cost $1358 in interest totaling $5250. Total for both loans, $3009 interest costing $10838. Paying this off immediately will save $280/month of payments for 38 months and save $3009 in interest.

The $9584 loan will cost you $1153 in interest, total cost $10737. Paying this off immediately will save $351 of payments and save $1153 in interest.

Valuewise:

• The two smalls total $7761 principal and will cost $10838 to pay full run (interest $3009).
• The large is for $9584 and will cost you $10737 to pay full run (interest $1153).

That's right. The two smalls charge you over 2-1/2 times the interest.

Minimum payment "wise", the two loans totaling $7761 vs. the big $9584 one:

• Payoff 2 smalls, $1239 remains, and $357.93 payment per month for 30 months.
• Payoff the big, you are $584 shy, plus $280.21 payment per month for 38 months.

So you can increase your cash flow by almost dumping the larger monthly payment, but really that $77 you'll get is just new debting, since you pay through the nose for it with over $1800 additional interest accrued that way. ($47/month for the 38 months).

Answer 2

The optimal strategy of paying down the debt depends on the criteria of optimality. Oftentimes it is considered desirable to pay as little interest as possible, which coincides with paying down the most debt given the fixed cash inflow.

For this set of criteria, the strategy is really straightforward: make minimum payments on all outstanding debts, and direct all the extra cash towards the one with the highest interest rate.

Given the list in the question, this amounts to paying in the 1 -> 2 -> 3 order down the list.

To put some numbers behind these words, let's do some math. First, let's calculate the total remaining interest to be paid on each of the loans, assuming that only minimum payments are made. This then comes out as $1,651.44, $1,357.98 and $1,153.11 respectively, in the order that the loans are listed in the question.

Then, let's consider the following scenario: the $9000 of extra cash is used to pay off loans 1 and 2, still leaving $1,238.45 to be paid towards loan 3. That would eliminate interest for the first two loans (assuming here for simplicity that no interest has accrued since the last payment), and reduce the total interest for loan 3 down to $861.46, for a total interest reduction of $3,301.08.

Finally, let's consider an alternative scenario: all of the extra $9000 is paid towards loan 3, leaving 1 and 2 in the state they are now. This almost completely pays off loan 3, reducing its total remaining interest to just $6.11. However, interest for loans 1 and 2 is unchanged. Therefore, the savings are only $1,147.00 in terms of the total interest. In other words, scenario 2 means paying $2,154.08 more than scenario 1 over the lifetime of all of the 3 loans.

Answer 3

Loan 1: 3,867.35 - 23.55% interest rate 9/48 payments @ 145.59 / month

Load 2: 3,894.20 - 19.03% interest rate 9/48 payments @ 134.62 / month

Loan 3: 9,584.80 - 8.99% interest rate 6/36 payments @ 357.93 / month

This is one of those times that the debt avalanche method and debt snowball method are in total agreement. Pay off Loans 1 & 2 and put a dent in loan 3.

Your goal is not free cash flow, your goal should be to be done with this debt. It looks like your balance will be about 8400 on loan 3 with this 9k. Here is your goal, be done with loan 3 in 8 months from now. You should be done with all these loans by Thanksgiving (if in the US).

So if loan 3 is the only one remaining, you will have $640/month to throw at it just from this small part of your budget. You need about $1080/month to retire this in 8 months. Can you cut your budget and find $440/month? Maybe, maybe not. Could you work some more (like a second job) and net $440/month? Easily.

Do that and don't worry about free cash flow. If you shoot to have this paid off in 8 months, you will probably be done in less than 6. Heck if you delivered pizza 2 nights a week, you could probably be done with this in less than 6.

Answer 4

i would suggest something slightly different from most folks here...

You are used to your monthly payments now.

Step 1 agrees with almost all folks in this thread.. Payoff the highest % loans 1st. This should kill 1 & 2 and put a dent into 3...

Now my different suggestion:

Increase the payment of loan 3... Make it about 140$ more each month (You knocked off about 280 from your montly payments already by paying the loans back).

That has the added benefit of NOT GETTING USED to the extra money. Once you are done with credit 3, put half of the monthly payment into a saving account. This will give you the feeling of having more money, and it will allow you to build your emergency blanket...

[Edit: Clarifications and small typo]

Answer 5

You can easily calculate how much you have borrowed (3867.35 + 3794.20 + 9584.80 = $17246.35), but it is important to note that this is not how much you owe.

How much you owe is the number of remaining payments, multiplied by the minimum payment amount ((38 * 145.59) + (38 * 134.62) + (30 * 357.93) = $21385.88).

The difference between these two numbers is how much interest you're paying:

$21,385.88 - $17,246.35 = $4,139.53

This is the only number that you can change- one way or another you're going to pay off the full amount borrowed (principal), but you can reduce or even eliminate the interest ($4139.53!) by paying extra.

While it might be tempting to pay off the larger principal amount first (reducing 9584.80 to only 584.80!), this will only reduce your interest owed to 3044.34 (you saved 1095.19 in interest and your total amount owed is now $11,290.69).

On the other hand if you pay off the two smaller (but higher interest) loans first- you save around 70% of the interest owed (now a total of $864.88 in interest). However, the total amount you will have left to pay back under this scenario drops to $9111.23, which is $2179.46 less than the other scenario!!

The reason for this difference is subtle, but still intuitive -- the first loan (3867.35 @ 23.55%) ends up accounting for a whopping 40.5% of the total interest paid! The second loan isn't much better, accounting for 31.2% of the total interest. Thus paying off those loans all at once will result in saving over 70% of the variable portion of your debt (interest). While none of these figures account for snowballing the payments, the time to being debt-free is still shorter under the second scenario (14 months) than the first (15 months)!

Answer 6

I approach this as what's more important? The usual strategy focuses on total interest paid. For people asking these questions, that's almost never the most important. Instead, they're living paycheck to paycheck and have come into a windfall of cash. For such a person, the most important thing is to increase their cash flow, so that they reduce their dependence on everything going perfectly financially:

1. No emergencies that require even $100 more this month.
2. Paycheck is always on time so that automatic payments (or rent checks) sent out in advance of pay you are supposed to get clear without any overdraft fees (See #1).
3. No impulse buy of something or need to unexpectedly spend money to make you dip into credit, pay day loans, or some other debt increasing activity.

So, once you have identified what's more important, then you can make a decision. If it's more important to increase cash flow, paying the $9.5k loan is the clear winner. If you can tolerate reduced cash flow and care about saving the most money, paying the higher interest loans off is the decision to be made. If you don't care about cash flow (because you have enough), but are in a position to buy a house and need to increase your DTI, paying the $9.5k loan may be the better choice but the calculus here is a lot more complicated and involves where that $9k came from, how soon you're buying, and more.

Answer 7

I'm not a financial adviser, but I have around 20 years experience in trying to pay off my own debt. This is my advice based on my own experience and knowledge gained the hard way.

I agree with what most of the other answers say, but there is something else to consider that no one else (so far) has mentioned: your credit score/report.

Because of this, I disagree with the order @Harper says to generally pay off loans to the point where I believe his order is exactly reverse.

Pay off the unsecured debt first, then the secured debt, then student loans.

Having unsecured debt collectors come after you drains your bank and your paycheck to the point where you might feel the need to start more unsecured debt to "get out of the hole." Unfortunately, that's only putting you farther in. So is using paycheck lending services. The rates they charge you are often equivalent to a 1200% interest rate or more.

Secured debt collectors will take your stuff, but will tend to leave your cash alone. It's a bitc-, um, PITA, but you can find a cheaper car to drive or house/apartment to live in.

Student loan companies will call you incessantly, but they are willing to work with you. If they are federal loans, they might take your tax refund, but I've been so far behind on payment it wasn't even funny and they still didn't do anything besides call every day. I've even had them basically give up calling me for a while. It's not the best situation, but you aren't likely to see anything serious from them.

https://www.foxbusiness.com/features/how-closing-cards-and-student-loans-affects-fico-scores

Near the end of that article, Barry Paperno states:

The most critical scoring distinction between cards and loans tends to be within the amounts-owed category, where loan debt carries far less scoring weight than credit card debt, which includes credit utilization and some other debt-measuring calculations. For this reason, if you ever want to help your score by paying down some of your debt above and beyond the minimum payment, always pay your credit card balances before any loan debt.

Also, student loans can be deferred if you lose you job, and there are other things they can do in times of economic hardships. They can reduce your monthly payment to nearly nothing, while you maintain your good credit standing.

https://creditcards.usnews.com/articles/how-student-loans-affect-your-credit-score

As with most other loans, you can give your credit score the biggest boost by making your student loan payments on time. It's worth noting that student loans are typically treated as installment plans by the three major credit bureaus... Opting to defer on student loans, while not as ideal as repaying them because it simply delays the inevitable, won't hurt your credit score.

It also says:

In (U.S.) states where it is legal, employers may even check a job applicant's credit report before making a final job offer.

This means that if you lose your job, you might have a hard time getting another one, while having lots of debt. This is especially true if you work in retail, where you may handle money all the time. I've heard that register clerks are the biggest target for a credit check before hiring.

I agree with the need for an emergency fund and will suggest that it's more than just an "I'm unemployed" backup. As stated previously, it should b 6-8 months of bills, to include food and fuel. I'm going to say that's the minimum you should have saved, and you should have more ready for car, home, appliance, and other repair/replacement needs. I've gotten myself into trouble by paying my bills, only to need to figure out how to fix my car(s) the following week.

Your savings should be your "goto" for all emergencies, not your credit cards. Credit cards aren't evil, but they can get you into deep shi-, um, manure. Credit cards should only be there for extreme emergencies, where your savings just can't cover it all. They aren't usually used that way, but that's a different topic. However, if you pay off the credit card each month, before interest is applied, you can get away with using them to help boost your credit score. It's tough to maintain that discipline, with one misstep getting you interest charges, and more missteps causing you more problems. Again, most people aren't using them this way.

Now, back to the money bit you actually asked about.

Interest that you pay is your enemy. As others have done the math, I won't. Also, I agree with the snowball effect as well as paying off the largest interest rate first, and these coincide in your case, so there's not really much else to say.

Pay off the two high interest loans first. That leaves you $1238.45. Keep it as a start for your emergency fund. If you feel you need to put some towards the 3rd amount, put only $250-500 towards it.

You still want to pay that $9,584.80 off, so here's how to do it the "right way."

You just zeroed out 2 loans that gain you $280.21 worth of your monthly paycheck back into your pocket. Use part of that to roll into paying this loan. I'm going to suggest splitting it down the middle so you put $140.10 more each month toward the loan and $140.10 goes into your savings/emergency fund. (There's 1 penny left that you can just keep in your checking account.)

After a year, you'll have put almost $1700 in your savings account from your wage (plus whatever you kept from the $1238.45) and have paid that much extra to your loan. This is a great start. If you continue doing this, you'll have that 3rd loan paid off in under 2 years.

After that 2 years, you could have just over $4600 in savings. I've paid less than that for 3 out of the only 4 cars I've owned. Now you can save even more, since you have paid off that 3rd loan and can add another almost $500 a month to your savings. That's another $6000 a year you are saving at that point. That is, if those are your only 3 loans, which I suspect isn't the case, and you're "the average American."

After saying all that, you are going to pick whatever method you like best. So...

Good luck and I hope things work out for you!

@quid, bankruptcy should always be used as an absolute last resort. It stays on your credit report for 7 years, and it can block you from buying a house or car. Some lenders will still loan you money with a bankruptcy, but at very high interest rate, so you're likely to get back to where you were before the bankruptcy. Also, bankruptcy isn't always an option. Having less than $10k in unsecured debt usually doesn't let you have that option, and some people think it's a huge stigma against them, which will cause them mental pain not worth the financial savings.

I've been at the point where my bank account, then my wages, were garnished for $2500 debt. Bankruptcy wasn't an option and it wouldn't really have helped, since I had tens of thousands of student loans that wouldn't have been affected, which were most of the problem anyway. Also, a judge can decline the bankruptcy, so now you have the legal bills to also cover. The judge can also rule that you have to drain your bank to try to repay the loan before the rest is decided, and again the judge can decide what debt to wipe out.

Regardless of what you hear about Trump's bankruptcy's, it's not the magic "get out of jail free" card most people seem to think it is.

Answer 8

Most has been covered by the other answers, but I think there's still something to say about this "increasing cash flow" issue. The reason paying off the larger loan will increase cash flow more is because the maturity date of the loan is closer. This leaves long term loans that are charging less per month, but for more months. By requiring you to pay part of the principal each month, all of the loans are basically decreasing every month the amount of credit they're extending you. So the smaller loans are extending you a smaller amount in dollar amount, but a larger amount in the time dimension, and they're charging you a higher rate in exchange; that is, they're charging you more interest because the loans are longer, but then they're charging even more on top of that. It is common for lenders to do this, but not usually to this extent.

So, the question for you is: is it worth paying 23.55% for longer term loans? It's probably not, but that's a question only you can answer. But if the answer is "yes", then you should be looking for alternatives. Do you think that if you went to those people charging you 8.99% for a 36 month loan and said "Hey, I'd be willing to pay you twice as much interest if you bump the maturity date out a year", they'd say no? What about other lenders? You have one lender willing to lend to you at 23.55% for 48 months and another willing to lend 8.99% for 36 months. That's a huge range, and if your credit rating hasn't changed since you got these loans, it's reasonably likely that there's someone willing to meet you somewhere in the middle, such as 10 to 15% for a 48 month loan.

You could even try to get the lenders to bid against each other. Tell them you're going to pay at least one of these loans off, and whichever it is, that lender isn't going to get any interest from you. So are they willing to lower the interest rate (or extend the maturity date) to keep their loan from being the one paid off? Quite possibly not, but it's worth a try.

Answer 9

Your goal ought to be debt free and to build up a cash reserve.

Currently you're paying about $640 dollars a month ($638.14 to be exact.)

Paying off the first two bills will leave you with 1238.45. If you don't have a cash reserve then this money ought to be saved.

One of your side goals is to have some spare cash at the end of the month. I recommend that you pay at least $500 to your credit balance and put $100 into your cash reserve until you get to 2 months worth of expenses. This will leave you with $40 extra cash flow per month.

If you NEED more spending cash then (depending upon how many months of cash reserve you have) I would recommend "taking" the money from the credit balance. You need to be able to protect yourself. Have at least two months of cash reserve. (Ideally 4-6 months).

Answer 10

I would pay off the two highest interest loans first, and I would throw all of the remaining money at the last loan.

Paying off the 2 loans will free up 280.21 per month, while saving 3166.64 in interest over the next 39 months. That's almost 1000 per year for the next 3 years.

If you throw the money you are currently using to service the 2 more expensive debts, then you can be paying off 638.14 per month of the 8346.35 remaining from the third debt.

This strategy could work particularly well if you could consolidate your loans into a fresh loan over a shorter loan term with a lower interest rate.

You could be done with the third loan in around 12-14 months.