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Personal Loan vs Credit Card Debt: Which Should You Pay Off First?

You might be feeling overwhelmed, if you are juggling both personal loans and credit card debt. Each type of debt has its own rules, interest rates and conditions. They can even have different impacts on your financial health. Let’s break it down.

How Do Personal Loans and Credit Cards Work?

Personal loans and credit cards are different ways to borrow money. Personal loans are typically used for one off purchases, like home improvements or significant expenses. They come with fixed terms, fixed monthly payments and, typically, lower interest rates than credit cards. With a loan, you borrow a fixed sum and repay it over a set period. Loans also fall into one of two categories, they are either a secured loan (backed by collateral) or an unsecured loan (based only on your creditworthiness alone).

On the other hand, credit cards offer revolving credit. You have a credit limit you can spend up to, repay and reuse. While they are convenient for everyday spending or unexpected expenses, you may have to pay interest if you don’t pay the entire balance each month. They also come with annual fees and, if you make any cash advances, the costs can climb even more.

Why Credit Card Debt Should Often Come First

Usually, credit cards carry higher interest rates than personal loans. If you only make the minimum payment, interest charges will balloon quickly. This revolving credit can also hurt your credit score, especially if your credit utilisation ratio is high. Paying down your credit card balance reduces this ratio and improves your credit profile.

When Personal Loans Should Be a Priority

While credit card debt often comes first, there are times when focusing on a personal loan makes sense. Loans generally have fixed repayment terms and monthly payments, while credit cards can have introductory offers with 0% interest rates. If your credit card is within any 0% interest rate period, focus your repayments on any loans that you have to minimise the total amount of interest that you pay across all your borrowing.

If you have a secured loan, you may also want to prioritise repaying it ahead of your other debt to make sure any risk of losing the asset it is secured on is reduced as much as possible. But remember, even if you choose to prioritise loan repayments, you must still make at least your minimum monthly credit card payments in full and on time.

Balancing Both Debts in Your Financial Plan

If both your credit cards and personal loans have high interest rates, start by targeting the ones that cost you the most interest. This approach, called the avalanche method, can help you pay less interest in the long run. Equally, the snowball method that focuses on clearing smaller debts first has its benefits, as it can give you a psychological boost and keep you motivated to clear your other debt faster.

Debt consolidation is another option. You can simplify your monthly budget by consolidating both personal loan and credit card debt into one lower interest loan. Credit unions, banks and other finance companies often provide competitive rates for consolidating debt.

Regardless of your choice, remember to make your payments on time for both types of debt. This protects your credit history and avoids penalties like late fees or a negative impact on your credit score.

The Bottom Line

Whether you pay off a loan or a credit card first depends on your personal financial situation. If your credit card has a high interest rate or is maxed out, prioritise it. If your loan is tied to an asset or has significant penalties for late payments, focus there instead.

The best approach is to review your monthly budget, understand your repayment terms across all your credit products and make a financial plan that balances paying down debt, while improving your credit score. And whether it is loans or credit cards, being consistent and focusing on your overall financial picture are key to staying ahead.

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