Why You Should Pay High Interest Loan First

Posted by Nick Niesen on November 8th, 2010

Paying your loan is like renting equipments.

You see, interest rate is like the rent cost of money. It?s like you are employing someone else?s money and you have to pay that money salary. In money, the money?s salary is often stated in terms of the ratio between money borrowed and how much you have to pay for borrowing such money. That ratio is called interest rate.

For example, if you borrow $10,000 and you have to pay $3,000 per year for not paying that $10,000 then your interest rate is $2,000/$10,000=30%. Simple?

That?s assuming that the money you borrow is constant, namely $10,000. If you don?t pay your interests, then the $3,000 is added to your loan. So next year, you owe $13,000. Two years from now, you?ll owe $16,900. Got it? In Math, few functions increase faster than exponential function, and this is one of it.

If you borrow some money at 30% interest rate from a credit card company and 9.9% interest rate from your mortgage, then you are paying more money for your credit card company for every unpaid dollar loan.

Each dollar from a credit card company costs 30 cents per year, while each dollar from your mortgage costs 9.9 cents per year.

Think of it this way. Say each dollar that you owe is like your employees. Just like your boss paying you your salary for borrowing your time, you pay your creditor for borrowing their money. You should of course, try to fire the higher paid employee first. Why hire money from the credit card company for 30 cents per year if you can hire money from your mortgage company for 9.9 cents per year.

For simplicity's sake, say each dollar from a credit card company is worth the same with each dollar from your mortgage, obviously you want to pay less salary to the credit card company. So you should pay your credit card company first.

If you owe $30,000 from a credit card company and $30,000 from your mortgage, for the same payment, you?ll be free of debt cheaper if you pay your credit card company first.

I made a simulation and put the result in a very easy to understand table in http://fasterfinancialfreedom.com. Then, I translated the whole thing into English for even more sense.