Debt repayment
April 17, 2020 9:19 PM   Subscribe

I have a $15,000 line of credit with a 7.3% interest rate and a $18,000 personal loan with fixed weekly payments of $183.45 at 7.5%. Those weekly payments are non negotiable. Which should I pay off first? Or, do I pay off both at the same time?

I have no other debt. I estimate that I can be debt free in 2 years and had planned to pay off both at the same time. But, I'm wondering if it would be wise to pay off the $18,000 loan with fixed payments first to rid myself of that weekly obligation.

I have no emergency savings, and had wanted to free up some room on that line of credit as a cushion while I also start saving a bit of cash for emergencies each month.

Thank you for your help. When things are a little brighter I will seek professional financial planning assistance.
posted by anonymous to Work & Money (9 answers total)
You're right about room on the line of credit - pay that one off first.
posted by Dashy at 9:51 PM on April 17, 2020

In present circumstances, I would first prioritize having some actual cash, actually on hand (as long as you are living in a reasonably physically secure environment). Doesn't have to be a huge amount, but think: what if the banking system went down for a week? How much cash would you need to get through that period? That much.
posted by praemunire at 10:07 PM on April 17, 2020 [2 favorites]

I'm not Suze Orman, but I would prioritize paying the obligatory debt, setting up an emergency fund, and then paying back the line-of-credit loan.

Weekly payments, while inflexible, bring the loan principal down faster than typical monthly payments (if interest is compounded). Even at a slightly higher rate, the overall interest paid might be lower (unless it is not compounded). So it is what it is, an obligation, and so first in priority.

The line-of-credit loan can be paid with more flexibility, it sounds like, which would seem to give room to build a backup plan.

If you have no emergency savings, perhaps set aside some portion of what you pay to the line of credit to an emergency fund, and pay down the minimum to the line of credit, and occasionally more, as circumstances allow.

If your circumstances change for the worse, you will have some funds on hand to help address those emergencies. If things improve, you can pay down the line-of-credit faster — and still work on the emergency fund.

As an analogy, one thing we have done with car financing is to get a loan with longer terms (and an accordingly smaller minimum monthly payment). The reasoning is that more interest is paid — the loan is more expensive — if we only paid the minimum.

But as circumstances allow, we pay the minimum and throw more money at the principal. Over time we can pay off the loan early, making it cheaper. This is basically how I would handle the line-of-credit — longer terms, smaller minimum payments, with flexibility to pay more than the minimum, as the situation allows.

Secondly, we're in an era when money can be very cheap to borrow. If there is any way to refinance either loan, or both, I'd look into that: interest rates are currently very, very low. Any opportunity to do this would reduce the amount of interest you pay and so give you yet more room to build up the emergency fund you need.
posted by They sucked his brains out! at 11:59 PM on April 17, 2020

With no emergency savings, you need liquidity. I would pay off the line of credit first or even take the extra cash and save it until you have a month or two saved and then pay the line of credit. A line of credit can always be pulled so you have some risk that that liquidity will not be there when you need it, thus my suggestion to build up some cash reserves even while having loans with interest outstanding.
posted by AugustWest at 12:33 AM on April 18, 2020 [2 favorites]

Copy/pasting what I wrote in response to a similar question a couple of months back with some minor edits:

There are two schools of thought here:

The avalanche method involves paying off loans with the highest interest rate first. The snowball method involves paying off loans with the lowest balance first.

If you follow avalanche then you pay less interest and get out of debt sooner, all things being equal. But snowball pays off individual loans faster, which is motivating for a lot of people.

Take your pick. You can use to model what effect either strategy would have on the total amount this costs you and how long it will take.

Your two loans are very similar (similar rates and amounts), so the monetary difference between the two strategies is likely negligible. You don't say what the payments are on the LOC (if any), but focusing on the loan with weekly payments per the avalanche method is probably fine.

And you didn't ask, but you should investigate options to refinance. Rates are low right now.
posted by caek at 12:34 AM on April 18, 2020 [1 favorite]

One other potential factor: are either of these secured by collateral that is important to you (in particular, a home or a vehicle)? If one loan is secured in this way, you could prioritize paying down that loan, in order to reduce the risk that you'd lose that collateral if your situation changes.

There's a chance that refinancing could eliminate that risk, too. This might not be the primary factor for you, but it might be something to consider.
posted by gimonca at 5:33 AM on April 18, 2020 [1 favorite]

I agree with those saying to pay off the line of credit first, to prevent a situation of having to put an unexpected major expense on higher-interest credit cards.
posted by drlith at 6:21 AM on April 18, 2020

In the last financial crisis, one of my credit cards shut down my credit so don't assume the space on that card will still be available. (None of my other credit cards shut down my credit, and that company later declared bankruptcy, so this can happen even if you're doing everything right, not that I was.) That makes me think you should get a little savings first, like maybe a month of expenses or $1000.
posted by slidell at 11:43 AM on April 18, 2020

I have a $15,000 line of credit with a 7.3% interest rate and a $18,000 personal loan with fixed weekly payments of $183.45 at 7.5%. Those weekly payments are non negotiable.

In general I favor the debt avalanche method. But don't lose sight of the goal: minimize interest expenses. Before you choose which to pay off first, ensure that paying off early actually saves you money. Some loans are structured in crazy ways, such that extra payments go towards paying off interest you'd owe later, offering no benefit for borrowers to pay off early. Others actually come with a penalty for prepayment. Not sure where your personal loan fits. Read the fine print and figure out how extra payment is applied.

Assuming that you can make principle only extra payments, I would focus on the 7.5 percent first. The fixed payments offer you less flexibility than the LoC will as well. Probably best not to rely on headroom in a LoC, as those can be withdrawn.

Other random advice:

- It's probably worth shopping around for interest rates. refis might save you more than early payment.
- if you have the means, a credit card can be a way of freeing up some cash to pay off those loans. every card I use comes with a grace period, meaning if I pay the bill off in full every month, no interest is charged. In a sense this means you can convert a little bit of that debt into 0 percent debt floating on the CC. If you also collect some cash back, so much the better.
posted by pwnguin at 6:26 PM on April 20, 2020

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