I got a question from a reader recently and when I tried to e-mail her back the email bounced back to me. Seems pretty odd because it was persons full name at a very well-known company. It was a well thought-out question and I hate to leave it unanswered, so I figured I’d make a post of it. I hope she’s ready. I’ll give her my typical code name of Buffy Summers and change around the loan numbers a bit to protect her identity.
I have a loan situation that I need some advice on. I have been struggling with the best way to pay off 4 loans with the same interest rate. I want to pay these off in whatever order will have the least interest paid overall. I can’t seem to find any information through researching on the web as to the best solution for this (and I’m not much of a finance person either!) The monthly payment for these 4 loans is lumped together at $373 per month. I’d like to pay an additional $300 per month, but don’t know if I should apply this extra money "strategically" across the four loans or only to one. Does it make sense to pay the highest loan first so that I can tackle the interest portion of each payment earlier rather then later? I have been using this loan comparison calculator and after playing around with different numbers, it seems like it makes most sense to pay across all four:
Here are the loan amounts:
Current Interest rate on ALL four: 6.75%
Number of payments left: 197
Loan A: $6,000
Loan B: $8,000
Loan C: $11,000
Loan D: $19,000
Here are the different payment scenarios when applying an extra $300 (as I am understanding it):
Scenario #1: Apply extra $300 to lowest loan first
If I did this, I could pay off Loan A in 1 year, 7 months, with total interest paid of $327. I can apply the extra minimum payment towards the other loans, plus roll over the extra $300.
Scenario #2: Apply extra $300 to highest loan first
If I did this, I could pay off Loan D in 4 years, paying a total of $2,323.79 in interest (just for that loan, this doesn’t include the interest on the other 3). Again, this would leave me the extra minimum payment I had been paying towards Loan D, plus I can roll-over the extra $300 at that point to the remaining 3 loans. How can I figure out the total interest paid over the life of all 4 loans this way though? I need a calculator like the one I am using that ALSO lists the amortization schedule?
Scenario #3: Apply extra $300 equally across all 4 loans
4 extra payments of $75 are applied to each loan. This would be $11,947 in interest paid over the life of the loans. However, the smaller loans would obviously be paid off sooner, meaning I could just roll over that money to the other loans (and I am assuming this would lower the amount of interest even further). Is there an easy way to calculate this?
Scenario #4 (what I have been doing for the past 2 months)
Apply extra $300 across all four loans based on percent of each individual loan amount I make the following extra payments towards each loan:
Loan A: $40
Loan B: $55
Loan C: $75
Loan D: $130
When doing it this way, I pay $11,474 extra in interest over the life of these loans.
Am I doing these calculations correctly? How should I best apply this extra $300 each month so that I pay the LEAST amount in interest over the life of all these loans? I read alot about how its better to pay the lowest loan first because it’s "psychologically" better. However, I don’t care about the psychological aspect of paying these loans off, I care about paying the least amount of interest over time.
Here are my thoughts:
It mathematically shouldn’t matter if all loans are the same interest rate. Buffy should end up paying the same interest. I put the emphasis on shouldn’t because my math isn’t what it used to be. Also, I was too lazy to find a loan amortization calculator to hand her, but there should be some good ones at Dinky Town.
However, I can see some factors that Buffy should consider:
She mentioned the “current” interest rate on all loans is 6.75%. Are they locked into that rate for the length of the loans? If not, perhaps she can anticipate which might increase in the future and pay those off first?
I’m with her on the psychological aspect of paying off loans. In the end, she knows she’s got $X in debt to pay, so getting rid of it the fastest is best. Sorry Dave Ramsey!
Readers, can you let me know what else I missed? Also, please feel free to contact me with questions any time using the contact button at the top of the page.