Credit card vs. personal loan
Credit cards are more than stylish pieces of plastic. They’re symbols of credit that’s been extended to you from your bank. As a cardholder, you can charge purchases up to your allotted maximum amount. You make payments to cover your charges, and if you don’t pay off your balance within the grace period, you’ll be charged interest on what you owe.
Personal loans, on the other hand, are lump sums of money that are given to you by lenders. You pay back these usually unsecured loans (there’s no collateral) with regular, fixed payments. Despite their differences, they have one important thing in common – they’re a form of debt.
Which loan should you pay off first?
No wonder, one important question that many financial advisors often face from individuals is, when should they close their loans? "Exit strategy from the existing debts plays an important role in minimizing the interest burden on individuals. But there is need to prioritize your loan repayments because this ensures that your loans can be cleared in a systematic way to boost the available monthly surplus," says Nitin Vyakaranam, founder & CEO of ArthaYantra, an online financial planning firm.
Some experts suggest that you should pay off your debts from the highest interest rate to the lowest, as this will save you the most money over time. But there are also some other things to consider while prioritizing your loan repayments. Here we take a look at which loans should you pay off first and why:
Personal Loans
Personal loans top the priority list when it comes to paying off an existing debt. Personal loans are unsecured loans which are advanced on the basis of the borrower's credit history and ability to repay the loan from the available income sources.
"Being an unsecured loan, personal loans are often offered at a higher interest rate. A higher interest rate necessarily means higher EMI payments. Though the charges for personal loan repayments are also on a higher side, it is always advisable to close this high interest debt once an individual has enough surpluses," informs Vyakaranam.
Unproductive loans
Loan instruments such as gold loans, loan against property, loan against fixed deposits and insurance policies, loan against PF and auto loan do not attract any tax benefit. Such loans should be paid off based on the interest burden. The interest rate on gold loans and loan against property, for instance, is dependent on the pledged value and the loan amount.
For example, if an individual opts for 50% of the value of gold as loan, he/she is expected to get a better rate compared to those opting for the 80-90% of the value as loan. These loans hold a lesser interest rate compared to personal loans. Loans against fixed deposits, insurance and PF attract lower interest rates than the gold loans and loans against property.
The increasing educational expenses have aided in the increased demand for educational loans. Educational loans should be given second least priority before closing off the existing debts. The reason behind it would be the tax savings one can enjoy on the educational loans. One can claim tax benefit on the interest payments being made towards educational loan availed from approved institutions. So essentially the interest payments can be offset by the tax benefit and hence one is advised to pay off educational debt only after paying off other debts.