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Which Loan Should You Pay off First and How to Start Saving?

Updated: Jan 11, 2021

If you clicked on this article, you are probably the proud owner of an expensive education, a stack of maxed-out credit cards, medical bills or some other burden of debt. Misery loves company – more than 25% of Millennials have over $30k in debt in the United States and only 22% are completely debt-free. And you’re wondering how to start saving…

Which Loan Should you Pay First?

Now that we got that out of the way, which loan is best to pay off first: The smaller, lower interest rate loan or the larger, higher interest rate loan?

Most experts would say to pay off the loan that accrues the highest interest rate because you save on that higher interest by paying it off first, the caveat being that it may take longer than some of your smaller loans if the principle is higher. Dave Ramsey, however, suggests paying off your smaller loans first to get them out of the way while you work your way up to your largest loan.

An intelligent and reasonable argument can be made for either method and it depends on one’s own finances and priorities.

It’s beneficial to calculate how much you’d be saving with each loan using the individual interest rates and your estimation (based on your income and spending) on how long it will take you to pay it off. When you sit down and crunch the numbers, you’ll be able to see which strategy is best for you.

Consider using a calculator tool to help you figure it out!

How to Start Saving?

What if you don’t have any surplus to pay off your loans? Lifehacker suggests these general policies to start reducing debt or building savings that holds true for virtually every financial guru:

Step 1: Spend Less Than You Earn

In the long term, spending less than you earn is imperative to your personal financial stability. Did you spend more than you earned this month because of holiday shopping? Wedding season? Paying for tuition? The key phrase here is in the long term. If you’re consistently spending more than you earn, however, you need to find alternative means of income or cut your spending.

Step 2: Pay Off Debts & Build Your Savings

Whatever loan you decide to pay off first, eliminating your debt is advised before investing. In fact, it’s recommended to start building your savings up to a level you’re comfortable with before turning that savings into investments.

Step 3: Switch From Saving to investing

Once you feel financially stable, either because you’ve successfully reduced your spending below your earnings, you’ve gotten rid of nearly all of your debt, or you’ve built up a hefty savings account, you should begin investing your money. Lifehacker denotes the difference between this recommendation and your typical 401K. In addition to retirement investing, investing your money will yield better returns than keeping it in a savings account. Lifehacker says index funds, the most frequently recommended fund by prominent financial gurus, is the way to go and here at ETFication we would have to agree!

If you want to learn more about investing, make sure to read this section.


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