Should You Pay Off A Credit Card Or Auto Loan First? How To Decide
Debt, specifically credit card debt and auto loans, is one of the most crippling pieces of most people’s financial story. What seems like a good purchase at the time quickly becomes years and years of payments. Those payments include tens of thousands of dollars of interest to the bank. And for what?
A car you don’t really enjoy?
An expensive outfit you thought you needed at the time but only wore once?
If you’re trying to improve your finances, you are most likely trying to eliminate this debt as fast as possible. So which one should you pay off first? Which one is hurting you more?
Should you pay off your credit card or auto loan first?
In most cases, paying off credit card debt before an auto loan is going to be your best option. The interest rates on credit cards are usually 3-5x higher than an auto loan. Credit card accounts usually charge an interest rate ranging from 18-25% where auto loans are usually around 3-6%. Credit card debt also grows exponentially while the amount of interest you will pay on an auto loan will be the set at the beginning of the loan.
While tackling credit card debt is TYPICALLY the best option, it isn’t always the right one. In this article, we’ll examine the steps you should take to make the best decision based on your situation. Everyone’s financial situation is different and taking cookie-cutter advice on how to do things, especially with your money, is something I wouldn’t recommend.
Credit Card Debt vs. Auto Loans
While credit card debt and auto loans are both types of debt you’ll want to pay off as soon as possible, they aren’t created equal.
Interest rates are one of the most dangerous aspects of borrowing money. They can be used in your favor though. When you invest money, you want HIGH interest rates because it allows your money to grow exponentially at a quicker rate. But this can be a double-edged sword.
When you take out an auto loan or go into credit card debt, the bank is investing in you. That means you are paying them interest and they are making more money. An auto loan with a 3% interest is going to cost you much less than a credit card with a 20% interest rate.
In addition, interest rates on auto loans are usually set for the life of the loan. You are going to pay 3% (or whatever your interest rate is) every year for the life of the loan. On the other hand, credit cards usually have a variable interest rate. In simple terms, the rate can go up or down at any time, meaning that you can’t guarantee what the cost will be on any given day.
A dangerous game to play if you ask me.
How Credit Card Debt and Auto Loans Are The Same
For some reading this article, it may be too late to hear this but you have a choice. You have a choice to go into credit card debt or to buy that new vehicle.
When talking about credit cards specifically, I want to remind you of the golden rule. I live by this rule and it’s the one constant that I think everyone should follow. It gets overlooked and when that happens, you get into trouble. That rule is:
Pay off your credit cards in full every single month and never carry a balance.
If everyone followed this rule, then there would be no credit card debt. We know, and you may personally know, that it’s a hard thing to do or maybe you didn’t even know to do it. That is okay. What’s done is done, and it’s time to move on, learn, and do better.
If you want to learn more about how credit cards work check out: How Do Credit Cards Work? – A Simple Guide With Examples.
The good news is that both credit card and auto loans allow you to make more than just the minimum payment. Yes, you can pay them both off early and I would suggest you do that. If debt makes you feel uneasy, or if you are getting charged high-interest rates, then you should be putting every spare penny towards that debt.
As another avenue for stress relief, if your car loan specifically is weighing you down then consider selling the car. Yes, this may seem like an extreme but if you bought a car that you can’t afford, it may be the only answer. There is no shame in driving a 20-year-old car. It may seem like you are taking a step back at the time, but in a couple of years, you’ll be thanking yourself for making that decision.
Focus On Debt With An Interest Rate Over 5%
When working with a client, one of the first things I do is compile a list of all of their accounts and debt. Credit card debt, auto loans, mortgages, etc. From that list, we write down the amount, the payment, and the interest rate.
What I always suggest they do is focus on eliminating any debt with an interest rate of over 5%. In most cases, this puts the focus on credit card debt and student loans. These interest rates will range from 18-25% and 5-10% respectfully.
The reason we do this is to save as much money as possible. Yes, we want to eliminate the auto loan and eventually the mortgage. But as we stated earlier, the interest you’ll pay is set where student loans and credit cards have variable interest rates. We’re minimizing our risk by eliminating the unknown first.
No matter what my client decides they are comfortable with, I make sure they are at least making the minimum payment on all of their debts. No matter what. Along with that, as soon as they pay down any high-interest debts (credit cards, student loans) to immediately shift those funds to lower interest debts.
Making them a debt paying machine.
The Bottom Line
For most reading this, it will be your best option to pay off your credit card debt before an auto loan. Remember, no matter what account you choose to pay off first, make sure that you are at least paying the minimum on both.
Being in debt is one of the least enjoyable aspects of anyone’s financial life. You should do everything you can to get rid of that debt as fast as possible. Yes, this may mean skipping a vacation or not getting that new car. It may even mean selling the vehicle you have now and downgrading.
What may seem like a huge sacrifice at the time will be a decision you most likely look back on and are thankful you did. There’s a time and place to have debt and use debt to buy assets. But the unnecessary debt will never benefit you.
Credit card debt and auto loans are unnecessary debt so do whatever you need to pay them off as quickly as possible.
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