High Interest Rates - Which Debt Should You Pay First?

By David M Siegel

Every month millions of Americans get their bills. The incredible weight that interest rate has on our paychecks is impossible to ignore, whether it is coming from credit cards, house mortgages, car payments or even student loans. Variable-rate mortgages have recently jumped to higher levels, making some of us feel the tremendous side-effects. People have lost their homes while others are outraged with the new mortgage payment. A number of people have found an alternative to paying the high interest rate, they tap into their long-term saving funds. However, such a decision should not be made from frustration but rather with clear analysis.

First, interest rate is the cost of borrowing money. Therefore if you are going to prepay debt you should prepay the loan that is costing the most, the one with the highest interest rate. Deciding the true interest (effective interest) rate might be a little tricky. For example, a house mortgage might have jumped from 7% to 10%. However, if you are in a high tax bracket with an effective tax rate of 30%, deducting the home mortgage interest rate from your taxable income leaves the effective interest rate to be only 7% (10%*(1-effective tax rate)).

A loan should be prepaid only if two conditions are met: you can't get a higher return on your money anywhere else and this is the highest interest rate that you are paying on any other debt. If you can invest the money from your funds somewhere else and get an interest rate higher than 7%, then you are better of investing your money and continue to pay the mortgage at monthly payments. Furthermore, if you have loans, such as credit cards, that charge you more than 7% interest rate then you should be repaying those debts before ever prepaying your house.

Similar analyses should be used to decide whether or not to prepay your student loan. The interest on your student loan is deductible up to 2,500 dollars, if you are making less than 65,000 dollars and are not a dependent. If you are thinking of prepaying student loans you might want to prepay some of your credit cards instead.

For more information about Interest-Rates, visit the popular blog at http://newinfopost.com/credit/interest-rates.

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