Which Loan Should You Pay First?

These days it is tough to find salaried individuals who do not have some kind of loan. As financial products, loans have been very popular and will continue to remain so because of their ability to boost purchasing power. If used judiciously, loans help fund your purchases, even when you cannot make payments in full immediately. Problems arise when there is an over-dependence on loans. Ask your friends who have multiple loans and are not able to handle them – and you will know how difficult it can get. Alternately, you can watch the Saif Ali Khan starrer ‘Tara Ra Rum Pum' that came out in 2007, which deals with this subject.

If you are in a similar situation with multiple loans, then you urgently need to prioritise your loan repayments. This will ensure that all your loans are cleared in a systematic manner. Gradually, your available monthly surplus will get a boost too. The general rule of thumb is to pay off the loans with the highest interest rates first – but this is just a theory. There are other things to consider while prioritising your loan repayments.

Personal loans

These are one of the costliest loans when it comes to the interest rates because these are unsecured and are generally advanced based on the borrower's credit history and ability to repay the loan from available income sources. Though EMIs need to be serviced regularly, it is always advisable to close this high-interest loan as soon as you have some surplus funds at your disposal.

Gold loans, auto loans, loans against FDs

These loans do not provide any tax benefits and should generally be paid off based on the interest burden. For example, the interest rates on gold loans and loan against property depend on the pledged value and the loan amount. If you opt for 50% of your pledged gold's value for your loan, you get it at a lower rate than if opt for 70-80%. These loans charge lower rates than personal loan. Within them, loans against FDs and PF accounts attract lower rates than gold loans and loans against property.

Educational loans

Once you are done paying off the types of loans listed above, only then should you focus on paying off education loans. This is because education loans are not as costly as personal loans and also receive tax benefits on the interest component. So interest payments are partially offset by tax benefits.

Home loans

Home loans have low rate of interests when compared with other loans, but longer tenures, sometimes running into decades. One can avail of tax benefits on both the principal repayment and interest payments. How and when to close a home loan depends on the tenure of the loan. In initial years, a major chunk of EMI payments go towards interest payments. It is in the last few years that these loans account for principal repayments. Therefore, it is advisable to consider prepayment during the first half of the loan tenure. Considering tax benefits, home loans should be paid off after servicing all other loans.

This approach of loan-repayment prioritizing is a general one and not specific to individual needs. For all loans, regular EMI payment need to be made. Please note that the strategies mentioned in this note help you prioritise your repayments, but it does not in any way recommend not paying any of your loans.