It’s not uncommon to find people who have multiple loans running concurrently. If you are one of those and have got some extra cash, which loan should you prepay first? You first need to get rid of the loan with the highest interest rate and move ahead in that order. Also, always factor in the prepayment penalty. Here’s the order of priority to prepay loans.
A credit card debt is the most expensive and, therefore, you need to get over with it first. The rate of interest you pay on it can go as high as 45% per annum. In fact, try and pay off your total outstanding balance every month and avoid rolling over credit to the next month by settling the minimum dues. A back-of-the-envelope calculation shows that on an outstanding balance of Rs 5,000, if you pay the minimum amount of Rs 100, it will take you around 90 months to settle the entire debt.
The next loan to prepay is the car loan. Generally, you get a car loan for five years, but some lenders give it for a longer term. While paying off the car loan, do check the prepayment penalty, usually 2% of the loan. But in case you’ve maintained a good payment history, the lender may waive it. If the prepayment penalty is as high as 5%, then it may not make sense to prepay the loan.
The logic behind prepaying a car loan before a personal loan is that it lets you own an asset, your car, sooner.
EDUCATION AND PERSONAL LOANS
The rate of interest on whichever loan is higher should be pre-paid first, among the two. Usually the rate of interest in an education loan is usually 14-15% per annum.
In personal loans, the rate of interest can be as high as 25% per annum, but on average it’s around 18% per annum. You may even get it at 12.55% per annum. In fact, many planners recommend that it’s better to take a personal loan at a lower interest rate and pay off a credit card debt of a higher interest rate with it.
The last loan to pay off is the home loan. It’s the loan which runs the longest and is most prone to interest rate fluctuations in case you opt for a floating rate. But this loan gives you income-tax benefit.
Also, some banks don’t even charge a prepayment penalty. Even if yours does, you can always negotiate the fees or ask for a waiver.