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Which debt should you prioritize paying off first? Smaller (car) or bigger (home)?

First, read Best way to get out of debt

Now that you’ve read that you know that car debt is erosive debt. At InSight, if we can avoid erosive debt we do. With that being said, you still need to make a decision as to what to pay off. 

Income – Savings = Expenses

Always prioritize your future rather than paying off debt especially if it’s erosive unless:

  • The interest rate is higher than what you can earn somewhere else. I.e. If you were to invest that money properly in the market and earn overtime 8% and your interest rate on your car is 4% then there is no benefit to paying off your car faster.
  • If you’re someone that can’t stand debt I understand. I’ve known a lot of clients that can stand the thought of having debt and owing someone but try if you can to avoid this thinking. The value of compounding money is way more valuable than the immediate gratification of getting out of debt. Also, on average, people that pay off debt quickly typically find new ways of getting into debt or they start buying things within their budget they don’t need which hurts their future self.

A home is a form of accretive debt. Everyone should own one as it helps you grow your net worth. On top of that, there are great tax incentives in the United States to own one so paying it off quickly especially if your interest rate is low which over the past couple of decades they’re at historic lows. 

Paying off your house fast is essentially saying that you cannot earn more overtime investing that money than the interest you pay for your house. Unless you have a very high-interest rate (~6%+) it is hard to justify paying something off instead of investing that money. Investing also enables you to pay for unexpected expenses. It gives you your “room for error” to pay for things like a new water heater, roof, plumbing system, etc which is extremely important. Meanwhile, the person focused on paying off their debt may have little to no savings or investments and has to use a credit card (interest rate 18-25%) to pay for that same expense which is exactly where you don’t want to be. 

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