Debt elimination isn't easy, but it is essential for your long-term financial health. If you are fortunate enough to have a little extra money at the end of each month, you might be considering whether it's better to use it to pay down your car note or credit card debt. Paying the debt with the higher interest rate is generally the best bet.
One reason for focusing on paying down your credit card debt is that it probably features a higher interest rate than your car loan. By paying extra toward your outstanding balance each month, you will reduce the total amount you have to pay in interest on your debt obligations. As your balance shrinks, your minimum monthly payment will also decline, which gives you greater financial flexibility to pay off other bills if you wish.
An advantage to paying off your car note first is that you gain free and clear ownership of a valuable asset sooner. This gives you greater flexibility to sell or trade in the vehicle, as no lending institution will hold a lien on it. Once you've paid off your car, you can also lower your car insurance premiums, as the lender can no longer require you to carry expensive comprehensive and collision coverage.
Paying off your car loan early may not be a good idea if your loan includes a prepayment penalty. A prepayment penalty requires you to pay an additional fee, which is typically calculated as a percentage of the outstanding balance. Generally, the longer you've had the loan, the lower the penalty will be. Other prepayment penalties are structured so that the lender receives the full amount of interest owed, regardless of when the loan principal is paid off. Be sure to check the terms of your loan contract before prepaying your note.
Paying Off Smaller Balance
If there is a large disparity between your car loan and credit card balances, it can make may feel more satisfying to pay off the smallest balance first, regardless of interest rates. For instance, if you owe $1,000 on your car and $10,000 in credit card debt, you may be able to pay off the car note relatively quickly. You can then devote the monthly car payment amount to your credit card debt. However, having one less bill to pay is a psychological rather than a financial decision -- typically, paying higher-interest debt is the best financial move.
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