Dear Money Living: I need some help. I have outstanding student loans and a car loan I’m paying off. Which should I pay off first, my car loan or my student loans? My interest rate on my car loan is 8% and student loan is 5%.
Dear Reader: Consider the following:
- The car loan carries a higher interest rate. Student loans in recent years have been under 5%. However, auto loans for people with reasonably good credit are approximately twice that. As a general rule of thumb, you pay off the higher interest rate debts first regardless of the type of loan be it car, personal, student, or credit card debt. Paying off the higher interest debt will save you more money in the long run. In the case of a car loan, the terms of the loan will be between four and six years. Assuming the car loan of $12,000 with reasonable credit, the payment would be approximately $300 per month with an interest rate of 10%. The interest payment to the bank would be roughly $100 a month. Getting this loan paid off as soon as possible would free up a substantial amount of take-home pay every month as well as allowing you to make better use of your hard earned dollars than handing them over to a bank as interest.
- There are few things that can build up or repair a person’s FICO score better than paying off a car loan. Student loans do not help nearly as much. Once you’re done with college, it is imperative that you see to it that your credit score with the three bureaus Equifax, Experian, and Transunion is as high as possible. Excellent credit will save you money via a lower mortgage rate on your future home, cheaper auto insurance premiums, and in some cases even with better employment.
- The minimum monthly payment on student loans is usually manageable in comparison to a car loan because the terms of the loans are longer – usually ten years. The name of the game after college is building up credit and cash reserves. This is because much of your startup costs in beginning your post-college life will require money. A small student loan payment can be managed with relative ease until your income is sufficient to allow for an acceleration of the loan repayment.