Personal Finance

Who’s right ? Paying debt

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  • Dec 19th, 2020 1:53 pm
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[OP]
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Apr 21, 2014
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Who’s right ? Paying debt

Hey guys/girls was having this discussion with my cousin. He is about $20k in debt. 15k on credit card (or cards not sure) and I’m assuming interest rate is around 18%. He also has a personal loan at 7% but it is an amortized loan , and he pays about $470 a month. His loan balance is around 5K.

He is getting a 5-7k bonus and asked me what he should do. He was thinking paying down the high interest debt, I told him to pay off the amortized loan in full, because it has the biggest impact on cash flow and he can then free up that $470 a month and snowball it on the card(s).

Thoughts? Who is right in this situation?
46 replies
Sr. Member
Jun 14, 2018
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Your friend's right. Always pay off the one with the higher interest rate. The fact that more immediate cash flow is freed up by paying off the smaller loan is irrelevant. If he wants to pay off the loan as fast as possible, pay off the one with the higher interest first.
[OP]
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MarinersFanatik wrote: Your friend's right. Always pay off the one with the higher interest rate. The fact that more immediate cash flow is freed up by paying off the smaller loan is irrelevant. If he wants to pay off the loan as fast as possible, pay off the one with the higher interest first.
It wasn’t an issue about the smaller loan it was amortized loan vs mainly interest only. I think minimum payment on credit card would be around $300 but minimum payment on the amortized loan is $470.
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Jun 14, 2018
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abc123yyz wrote: It wasn’t an issue about the smaller loan it was amortized loan vs mainly interest only. I think minimum payment on credit card would be around $300 but minimum payment on the amortized loan is $470.
If your friend cares more about immediate cash flow, then sure pay off the one with the higher monthly first, but if his goal is to pay off the loan as fast as possible, then pay off the one with the higher interest rate first. I don't think it needs to be said that paying more interest = bad.
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Dec 5, 2006
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If he has cash flow issue, shouldn't he keep the bonus to pay the bills?

I would agree with others, always pay highest interest one
[OP]
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smartie wrote: If he has cash flow issue, shouldn't he keep the bonus to pay the bills?

I would agree with others, always pay highest interest one
I don’t know if he has cash flow issues. I suspect not since he’s asking me what debt to pay off first. I will let him know if he’s having cash flow issues then pay off the loan to free up more cash, but if he’s looking to clear the debt the fastest then put it against the card(s) with the highest interest rate.
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Aug 18, 2005
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abc123yyz wrote: Hey guys/girls was having this discussion with my cousin. He is about $20k in debt. 15k on credit card (or cards not sure) and I’m assuming interest rate is around 18%. He also has a personal loan at 7% but it is an amortized loan , and he pays about $470 a month. His loan balance is around 5K.

He is getting a 5-7k bonus and asked me what he should do. He was thinking paying down the high interest debt, I told him to pay off the amortized loan in full, because it has the biggest impact on cash flow and he can then free up that $470 a month and snowball it on the card(s).

Thoughts? Who is right in this situation?
Mathematically, going after the highest rate will pay it off the fastest.

But the real advice I would give is to pay off the amortized loan. The reason is that people generally got into debt because they were acting in an emotional manner to begin with. The real problem is emotional, not financial. And what will do the best for him emotionally? Actually killing off a whole loan will give him more motivation to get rid of the other one. If he focuses and does it fast, the actual dollar differnce in accumulated interest will be negligible.
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Jun 14, 2018
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Jucius Maximus wrote: Mathematically, going after the highest rate will pay it off the fastest.

But the real advice I would give is to pay off the amortized loan. The reason is that people generally got into debt because they were acting in an emotional manner to begin with. The real problem is emotional, not financial. And what will do the best for him emotionally? Actually killing off a whole loan will give him more motivation to get rid of the other one. If he focuses and does it fast, the actual dollar differnce in accumulated interest will be negligible.
This is bad advice. You don't know that the cousin has a problem with debt or has motivational issues paying it off. You know what could also give him more motivational in paying it off faster? By seeing the total amount of the debt going down faster and that's done by first paying off the one with the higher interest.

The difference here is like $500-$700 of interest per year. I don't know why anyone would willingly want to pay an extra $500-$700 per year when they don't have to.
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psyfer wrote: Here's what Dan lok recommends
Is this guy good? Use to see a lot his ads in Instagram
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Question... what bank are the 19% credit cards with?

Because all the big bAnks have low interest rate options. You can switch to that for a low annual low. It would count as a product switch, & not a new application. So no worries about qualifying.

E.g. BMO no fee mc’s are 19.99%
But switch to the preferred rate card @ 12.99% for only $20/yr.
Thats a 7% savings in interest. For every $1000 you owe thats $70 in savings per yr!
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Check out coffeezilla on youtube. Seems very "cult"-like. I'm sure you can get some positives as with all internet "gurus". Some peeps are extremely brainwashed though... it's pretty sad to be honest.

Now back on topic... I will say it depends on the personality... i know it doesn't make sense mathwise... but remove a loan may have a mental affect that snowballs him/her to keep at it and attacking their debt, even though it is a lower interest rate. Sorta like getting the low hanging fruit so to speak.

I would pay off the high interest first btw.
smartie wrote: Is this guy good? Use to see a lot his ads in Instagram
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Jan 31, 2006
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Dumb the bonus into the personal loan and cleared it out. The credit card debt pay it as much as he/she can, the faster it got paid off the better.
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Jun 12, 2008
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Ripley
Can he make extra payments on the loan? Is there a penalty?

Math wise he will save more money by paying off the high-interest credit card first. Mentally, he needs to decide which will give him more motivation to keep paying down the debt. Hopefully, he has fixed whatever got him into so much debt.
Member
Apr 16, 2015
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The loan will take care of itself within a year since he is basically forced to pay off $470/month, so don't worry about that. The credit card is harder to pay off if he's just making minimum payments because the high interest keeps adding on and it's tempting to buy more stuff on it. So,
- put the bonus on the card, which will cut it by a third
-switch to a lower interest card, and
- once the loan is paid off, add that $470/month to his current credit card payments and the whole thing should be paid off in about 2 years.
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I feel like the guy should take out a BT MBNA CC.. and transfer that balance over to that.. then pay off his entire loan off.. BUT after paying off the loan, SAVE/invest that money every month and then do a massive lump sum payment for the card when the 0% promo is over.
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I would recommend paying off the highest interest rate debt first and then pay the lower interest rate debt.

This is why I would generally recommend paying off any credit card debt first (especially with credit card interest rates ~20%) before looking at any other debt.
Sr. Member
Jul 24, 2019
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abc123yyz wrote: Thoughts? Who is right in this situation?
Can I choose none of the above?
I think:
- take $1000 of the $5-$7k bonus and put that in an emergency fund & invest the rest
- pay the minimum on both of the loans: the $15k and $5k loans
- get a side hustle and pay of the $20k by December 31, 2021

I think there is something more going on, why the $20k debt occurred. That should be addressed. It's not about the bonus at all.

My 2 cents worth...
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Nov 15, 2004
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If he has multiple credit cards and he's barely keeping on top of them, pay off the ones with the smallest balances first to free up cash flow and then snowball them. Why? Credit card minimum payments usually hurt cash flow and hit your cash flow harder than the annual interest rate suggests.

Amex, for example, requires a minimum payment of the greater of 3% of the total balance or $10 every month. On a $5,000 balance that's $1800 in minimum payments to service the initial $5,000 debt, with a $1,000 increase in the balance over one year if the annual rate is 20%. If he has 4 cards and he's making the minimum payments on them he can clear the debt much faster by eliminating the smallest balances first so he doesn't have to pay the high minimum payment amounts, then snowballing the increased cash flow into the higher rate card.

"Always pay down the highest interest rate first" is a really simplistic view of the situation targeted at idiots, and doesn't always reflect the best way to approach the situation. Cash flow is the most important thing when it comes to debt repayment. Calculate the EAR vs APR and make your decision accordingly.

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