Which loan should I pay first with my ₹3 lakh bonus?
Simran, 32, currently has three kind of loans – a ₹5 lakh car loan, a 3 lakh personal loan and a 2-lakh credit card loan. On receiving a quarterly bonus of ₹3 lakh, Simran intends to pay off part of the loan but she is yet to decide which ones to pay first.
In most cases, investors decide on this based on the EMI amount they are paying, said Deepesh Mehta, Founder, Happy Investor Finserv LLP, Bangalore, adding, for example, if an investor is paying car loan EMI of ₹15,000, personal loan EMI of ₹10,000 and credit card loan of ₹3000, the most common scenario is he will pick the car loan first.
“But, this is an erroneous approach.” Mehta asserted, there is a concept called as laddering of loans. This denotes, one should close the loans based on interest rate, i.e. first you pay up the loan for which you are paying the highest interest rate and then gradually go down.
Now, in this case, it can be assumed, the interest rate for the credit card loan would be highest, i.e. around 40%; interest rate of the personal loan would be 12 to 13% and car loan would be 8%.
Also, the tenure for car loans are usually 7 to 10 years, and for personal loans and credit card loans, they are most often 2 to 3 years. Hence, the EMI amount for the car loan would be much lower than the other too.
So, here is what Simran should do:
Scenario 1: On getting a ₹3 lakh bonus, Simran should first close the credit card loan and pay part of the personal loan.
Scenario 2: In case she doesn’t have an emergency fund, (in most cases people who don’t have an emergency fund end up taking credit card and personal loan), she should first set aside ₹1 lakh as emergency fund and use the rest, i.e. ₹2 lakh, to close the credit card loan.
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