Which Debt Should You Pay First?
Written by Kelley Keehn
Friday, May 25th, 2018
Your immediate environment is comprised of coffee shops, supermarkets, websites, apps and all kinds of things — none of which have an interest in your long-term or short-term financial well-being.
Dan is the bestselling author of a number of books on how irrational people are when it comes to money, especially given the culture that we live in, with things tempting us at every corner.
Traditional economics states that we weigh the pros and cons of each financial decision and in doing so, always crunch the numbers. However, the growing field of behaviour economics reveals a very different story. Not only do we not adequately weigh all the information in a given situation, but even if we do know the numbers, we often ignore them. This is a frustrating trait we all fall prey to called irrationality.
When it comes to your debt, you want to be all-in with your eyes open. As you likely know, Albert Einstein thought compound interest was magic.
But it's only magic if it's on your side – not the lender's.
Which Debt Should You Pay Off first?
"Some advisors say you should pay off small debts first, because it gives you a feeling of accomplishment," he says. He makes a case that paying your small debts first may have positive psychological benefits, but "unless you really need a psychological boost, I believe you should pay off high interest rate debts first, because that saves you the most in future interest payments."
Doug adds: "It's not just the interest rate that matters, you must also consider the nature of the debt. If you have a 'callable' debt, like a line of credit, the lender can call in the loan whenever they want, so even though the interest rate on that debt may be low, it could disappear, so if you are worried about that risk, paying down your callable debts may be prudent."
He also says "secured debts, like a car loan or mortgage, are generally not callable since they have a fixed term, but if you don't make your payments the lender can repossess the security (the car or the house), so you may decide that for peace of mind it's best to eliminate your secured debt."
So How Do You Decide?
Should you pay down your callable line of credit with an 8% interest rate or your secured car loan with a 7% interest rate?
Tough one, right?
What should you do? Doug says "always make at least your minimum payment on all debts, otherwise you may incur extra penalties, and always have a plan!"
You Don't Have to be "Math-y"
Crunch the numbers and learn more with the Financial Consumer Agency of Canada's calculators here.
"With credit cards and lines of credit, make them off-limits. For example, you could cut up the credit cards, put them in the freezer or lock them in a vault. You still must repay them, though. Just make them more difficult to access. That way the debt can be repaid without getting further into debt."
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