Which debt do I pay first? (Part 1)

I heard someone call into a talk show recently asking which debt to pay off first. This made me realize that everyone doesn’t understand the impact of paying interest on a loan. I like examples so let’s use one for this.

Debt 1 – Owe $10,000.  5% interest rate. $10,000 x .05 = $500 interest payment every month.

Debt 2 – Owe $10,000. 10% interest rate. $10,000 x .10 = $1000 interest payment every month.

Deb 3 – Owe $10,000. 20% interest rate. $10,000 x .20 = $2000 interest payment every month.

Did you notice that the higher the interest rate, the higher the monthly payment? I used the same loan amount so that you could plainly see the affect of different interest rates on what you have to pay each month.

So, let’s say that $10,000 loan was for a car. On top of paying off the $10,000 which was the cost of the car, you are also going to have find an extra $500 a month at a simple 5% interest rate. But, if you have a 20% interest rate, you now have to find an extra $2000 a month. Ouch! At that rate you will have paid $10,000 in interest after only 5 months. That’s what the car costs!

Hopefully by this point it has become a little more clear how interest rates can affect you. Watch tomorrow’s post for suggestions on how to determine which loans to pay off first when you have different rates and different loan amounts.