Q: I have a $3k credit card debit and a $5k personal loan. The credit card has a higher interest rate but it’s a smaller debt, so I’m not sure which one I should try to pay off first. I also have $10k in savings for a home deposit, but I’d rather not touch that unless it’s better to use it to pay my debts. What would you do?
A: With interest rates at historic lows, the first thing I would question is what interest rate you’re getting on your savings. If it’s significantly lower than the interest you’re paying on your personal loan and credit card, and the savings aren’t locked away in a term deposit or earmarked for a home purchase soon, then it just might be worth considering paying off your debts and starting again.
You could then set up a new savings plan and put all that money that was going on your debts, including the higher interest you were paying, straight into a savings account.
But if you need to keep your savings then there are some other options to choose from.
1. Pay the debt with the higher interest rate first
You should always be guided by what the cost is to you when deciding what to pay off sooner, and in this case it’s the interest rates and fees on your debts that should determine your approach.
The higher these are, the quicker I would pay them off, and usually credit cards have a higher interest rate than personal loans. Credit card debt is also viewed as ‘bad debt’ because of its high interest rates, small minimum repayments, no fixed end date and no benefit to paying interest – such as appreciating assets with a home loan.
2. Consolidate your debts
Debt consolidation helps you manage your bills and involves putting a number of different debts into a single loan that has a lower overall interest rate.
You could do this by transferring your two balances on to another credit card, taking advantage of some of the 0% balance transfer offers in the market, though only if you would be disciplined in paying off the debt quickly.
Alternatively you could consolidate your credit card debt with your existing personal loan so you’re paying a lower interest rate and only have one bill to pay instead of two.
Remember that with most debt it’s important to keep it on a shorter term and pay it off as quickly as you can to enjoy the full benefits of consolidation. First however you need to do your homework. Check your interest rates and find out if you’d be hit with any early exit charges on the personal loan if you pay it off quicker.
You could also benefit from getting expert advice from a financial adviser who understands the full picture. An MFAA accredited mortgage broker can also provide you with useful information about different debt consolidation options.
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