Loans have become an integral part of modern-day life. Whenever we are short of funds while buying or doing something – like buying a home or a car, or pursuing higher education – we look towards loans. Although loans do increase our purchasing power and help up us fulfil our dreams, however over-dependence on any kind of debt often leads to a strained financial life and can even turn one’s financial goal topsy-turvy.
Therefore, while there is no harm in taking a loan, there is also need to close that loan as early as possible. However, the question that arises is – which loan to pay off first? That is, should you clear your personal loan first or auto loan or educational loan? Or is it your home loan which should be paid off first?
Experts say that it’s essential for one to consider a number of factors before deciding to pay down debt. “The first, and perhaps the most obvious, is to keep a track of the cash outflow against debt. Paying off any debt in advance, if possible, is always good. But as every loan is taken for a different purpose and has a varied tenure & interest rate, deciding which one to tackle first can be a challenging affair. One needs to cross them off the list in the right order after a careful assessment,” says Manavjeet Singh, CEO & Founder, Rubique.
Here are a few tips to follow while you decide to pay off the debt you owe:
1. Assess the loan’s impact on your financial position
While you are making decisions to pay off your loan, you must give a thought about what is best for your overall current and future financial situation. Any loan which can boost your financial position is a ‘good debt’. For instance, “home loans and education loans help in availing tax benefits. We must not take the pressure of closing any of them in a rush as long as we are able to pay regular installments. Instead, you can knock off the smaller balances first. Paying off the personal loans or credit card debts according to the interest rates will be a smart move as they are majorly availed to fill the gap of a cash crunch,” says Singh.
2. Calculate the impact on your pocket
In a multiple debt payoff plan, it is always advisable to pay off debts like personal loans or credit card debt that come with a high interest rate first because carrying a balance on a high interest rate credit card can cost you more, driven by the monthly finance charge. “The higher the interest rate, the higher will be the finance charge. Moreover, the longer you take to pay off the card debt, the more costly it will turn out to be in terms of paying the finance charges,” observes Singh.
3. Check the credit score impact
Keeping an eye on your credit score is a must to maintain your creditworthiness for availing any kind of loan in future. Hence, while repaying a debt, one needs to assess the impact on credit score. For instance, paying off a lump sum credit card balance in one go can do wonders to your credit score.
Thus, “ideally, you should tackle bad debt first. If you don’t have bad debt, concentrate on paying off your highest interest rate debt, like credit card debt, personal loans, etc,” says Ranjit Punja, CEO & Co-Founder, Creditmantri.
However, some loans, like home loans, come with tax benefits. According to Section 80C of the Income Tax Act, repayment towards the principal loan amount allows you to avail deductions on the payment of the actual amount that you’ve borrowed. The maximum tax deduction allowed in the principal and interest repayments is Rs 1.5 lakh and Rs 2 lakh, respectively. “If your spouse is a co-applicant, then it means double tax benefits. However, keep in mind that these deductions can be only claimed if you’re staying in the house. Rented properties do not come under the purview of this Act,” says Punja.
There is, thus, need to prioritize your loan repayments to ensure that your loans are cleared in a systematic way and as soon as possible.