Last Updated on 15/07/2020 by Deepak Singla
When you borrow money be it from a bank or apply for a credit card, the intent is to pay for an expense using the credit borrowed at the current point in time & actually paying it back at a later date. But, at times it can get confusing to understand what should be paid off first, Loan Repayment, or credit card payment? Generally, credit card payment should be paid off earlier as the interest rate is higher than most of the loans and paying them off earlier prevents interest to pile up. This will also build a credit rating and reduce the credit card debt which on a direct level impacts credit utilization which is one of the biggest factors for a credit score.
There are multiple factors to consider when you are supposed to make the choice of credit card payment or Loan repayment first. The factors are mentioned below:
1. Assessment of how much debt one has
A comparison of how much loan repayment or credit card debt one is the first step in deciding what to pay first. Generally, as mentioned above credit card payment, is cleared first but, if the payments to a loan can be completed within the first instalments, it can be decided to pay off the debt first.
2. Understanding which debt costs more
A comparison of the interest rate in both kinds of debts is important to know what kind of debt will eventually cost more. so Which cost you more you need to pay early to get out it. Because it will increase your debt amount with power of compounding
3. Which of the two is easier to pay?
Student Loan is an example of a debt where one has options for repayment of your EMI or Loan Amount. For example, a time period is given where you do not have to eventually pay it off once the loan is sanctioned. When you take a loan, one can choose a repayment plan that is suitable based on your income level. Credit Cards do not provide such options, though they do offer a minimum payment plan and some of the companies might offer a break from payments as well.
4. Miss on Payments
What happens when one misses a credit card payment or a loan repayment is an important factor to consider while deciding what to pay off first. you need to be very careful about your loan EMI so that you never miss any of them.
5. What is considered good debt
Lenders while giving a credit card or a loan, view it very differently when it comes to the credit score aspect and the credit score determines whether one qualifies for a loan or mortgage & what are the conditions on which the amount is borrowed. The debt-to-credit ratio also gets impacted with both types of debt, the ratio is the number of monthly payments as compared to the total income. This ratio also affects major lending which includes loans, mortgages.
6. Can you cancel any of the debt?
There are cancellation terms that come into play for both credit cards and loans, but it differs from one lender to the other.
To conclude, it’s usually better to pay off the credit card bills payment first before loan repayment because of the credit factor & not having multiple repayment terms in place. But it depends on the situation you are in financially. For example, if you pay off a huge car payment at one go, it can help as not having a payment to make can make a better debt-to-income ratio for qualifying for a mortgage. Paying off a credit card that is close to being paid off might help in the same way. (You can read more about credit card here in case you haven’t applied for one).
It is important to make sure that the amount of debt isn’t always high, here are some tips to keep balances on lower side & your debt in order:
- Budgets are a good way to ensure that your expenses are in order. Planning is a good way to budget for expenditures and make sure that when you review the budget & see what can be cut.
- Living with friends and family can bring expenses down and reviewing rental expenses can help bring rental expenditure down.
- One should try to avoid addictive or mindless shopping so that one does not go overboard when it comes to expenditures.
- Using credit card rewards and rebates for cashback to pay off expenditures can bring down balances if you avoid overspending.
- Lower interest rates will greatly help in saving money if one has a good credit score to qualify for the same. Though for credit cards, there is an initial balance fee.
The decision to pay off which debt to pay first is a major one and can be an extremely hard one to make as well. One should focus on balances that have a higher interest rate which generally would be credit cards. The same interest rate strategy should be applied to even determine which loans repayment first as this will free up funds put towards debts and achieve goals that are debt-free sooner.