It’s hard to juggle multiple loans. Every month, they consume a significant portion of your paycheck. This goes doubly if you are juggling auto and home loans — likely two of the biggest purchases you’ll make in your life. As such, the combined balances and monthly payments can be huge.
Read this for a detailed guide on how to get out of debt.
If you pay one of these loans off entirely, your monthly payments will shrink drastically. But which should you prioritize? Which should you pay off first, your mortgage or your auto loan?
Start by comparing the details of your two loans. Which costs you more money each month? And which causes you more anxiety? It’s important to consider both your financial and emotional perspective..
Look up the interest rates and remaining balances on both your loans. You’ll find these on your last monthly statement, and you can always call the bank itself if you can’t find this information.
With this information in hand, let’s explore your options.
“Debt snowball” — pay off the lowest balance first
One popular option is to pay off the debt with the lowest balance first.
Just apply any spare cash toward this debt and once it’s gone, you’re one step closer to debt freedom. For most people, your lowest-balance loan will be your car loan, unless you’re nearly finished paying off your mortgage.
After you pay off your first debt, you can use the money you would have allocated for those monthly payments toward your outstanding balance.
Let’s say, for example, that your monthly car payment is $200, but you can afford an extra $100 a month. If you pay $300 a month toward your car loan, you’ll pay it off almost twice as fast. And once that’s gone, you’ll have an extra $300 a year to go toward shrinking your mortgage.
This allows you to be debt free much sooner. However, it also means that your current monthly payments should remain constant until all your loans are fully paid off. If it will clear your debt and let you fully own your car and home, though, it’s worth it.
“Debt avalanche” — pay off the highest-interest-rate debt first
If you’re trying to diminish the total sum owed, you should use your extra cash to pay off your debt with the highest interest rate first.
For example, if your mortgage has a high interest rate, it might behoove you to pay off this loan first, even if your auto loan has a smaller balance. If you do so, it will take you longer to clear both debts, but you will pay less money overall.
The “debt avalanche” method can be tough to commit to. Unlike the “snowball,” you don’t get the instant gratification win of a fully paid-off loan. But if you have the patience for it, this method will save you more money in the long run.
Keep your tax breaks — pay off your auto loan first
Did you know that you can deduct a portion (or all) of the interest on your mortgage from your taxes? For many people, this can be a hefty and helpful influx of cash.
Let’s say your family lives in a state with no income tax and is in the 15% federal tax bracket. If you just bought a home for $190,000 at a 4.5% interest rate, you’d get a tax deduction for $1,558 in your first year. That’s not pocket change.
Interest on auto loans for personal-use cars, on the other hand, is not tax deductible. As such, if your mortgage payments are saving you hundreds to thousands of dollars a year, you may want to prioritize paying off your auto loan first.
Investment alternatives — spend your spare cash elsewhere
If your mortgage interest rate is less than 7% (the average rate of return for the stock market), it might make more sense to invest your any extra money instead.
Let’s say your mortgage interest rate is a super-low 3%. If you invest your extra savings to earn an average of 7% in the stock market, you’ll likely come out with a healthier savings than if you’d put all that cash toward your payments.
Of course, you can lose money in the stock market as well, but in the long term, you’ll end up with more money in your pocket.
Make sure to find a brokerage you can trust to invest your savings in. If you don’t, you may as well have used that cash to pay off your loans early.
What’s the right choice for you?
Ultimately, the decision comes down to you. If you want to be debt-free ASAP and don’t mind paying extra in the process, pay off your smallest loan first.
If you’d rather pay the least total money towards your loans, pay off your highest-interest rate debt first.
Or if you’re looking to maximize profits and don’t mind staying in debt longer, invest your extra cash instead of committing it to either loan. But only do this if your interest rates are lower than 7% — the average earnings on the stock market.
If you’re just embarking on this process and need an auto loan or a mortgage with the lowest interest rates, SuperMoney can help. Compare rates for auto loans and mortgages with SuperMoney’s tools, and learn how to get the best rates on your loans.