Which debt to pay off first?

Thank God I am not an expert on debt. Or of debt repayments for that matter!

The caveat first – I hate debt. I hate debt. I hate leverage. I rarely do an Options trade, nor do I ever buy a share in a Futures trade. All assets have been paid and bought.

Now let me ask you a question: “If a 49 year old man has a 3 lakh personal loan (at 21% p.a), a credit card debt of Rs. 100,000 (at effectively 42%), a car loan of Rs. 600,000 (at 14%), and a home loan (at 12.25%) of 34,00,000 – and he gets a ‘gift’ of Rs. 300,000 – what should he do?”.

The biggest problem in being an expert is you have to tell the customer what are the options available – and let him choose.

Let us look at all the solutions:

1. He should take a top up loan for the house (assuming he can get a top up loan of Rs. 700,000), use the gift of Rs. 300k and pay off all the non mortgage loans.

2. He should pay off the credit card loan of Rs. 100,000 and pay down a part of the personal loan. Mathematically it is the best solution because he his paying off the most expensive loan first.

3. He should pay off a part of the housing loan – after all the house is biggest asset and the biggest loan.

4. He should apportion the money amongst all the loans in equal amounts – over all he gets a feeling that every liability is getting reduced.

Now if you are a client what will you do? The planner in me has confused you fully and completely. Sometime later I will tell you the disadvantages of all of the solutions!

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One Response to “Which debt to pay off first?”

  1. Dr Mohammed Ali Khan on July 28th, 2009 at 3:15 am

    Naturally paying of the High interest loans first makes sense..
    So in this Example he should pay of his loans in this order
    1. Credit card loan
    2. The remaining to pay of the personal loan
    and so on in decreasing order of interest rates

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