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Pay Off Car Loan or 0% APR Credit Card First?

This article was written by in Debt Reduction. 26 comments.


I always like questions about debt pay-off strategies because they’re partly about math and partly about psychology. The numbers are very important, and debt payoff strategies should not be planned or implemented without a good understanding of the long-term financial consequences. There are some cases where, from a personal perspective, it makes sense to formulate a plan that costs more in the long-run but alleviates other problems during its course.

That’s why I strongly encourage people to take a look at the Debt Avalanche method for paying off credit card debt before they blindly go with a different but popular solution. I understand why people are drawn to a strategy that theoretically takes longer to become debt-free and costs more in interest, and I have no problem with that choice as long as they recognize the long-term financial consequences of spending more money than necessary.

Today, a reader wrote in with a question about his debt payoff strategy.

I have $2,000 on a credit with 0% interest for a year and a car loan of $3,000 with 5.4% interest. My wife and I will owe big on student loans in Janaury and I want to get my car and/or credit card paid off fast. Should I pay extra on credit card payment or car? How important is it to pay off the 0% in one year, the interest will shoot up to 10% in April 2012.

I’ll answer the second question first, because it may have a bearing on the answer to the first question. It’s important to pay off the 0% balance in one year. First of all, although the credit card company is indicating the “go-to” rate will be 10% in April 2012, this is likely a variable rate. Most credit cards are using variable rates to get around the Credit CARD Act’s stipulation that makes it more difficult for credit card issuers to change (fixed) interest rates. It may be that when the introductory rate expires the rate on the balance is higher than 10%.

Also, when introductory rates expire before the balance has been paid in full, in some circumstances the go-to rate can be applied to the entire charged balance during the introductory period. That’s rarely the case with 0% APR balance transfer promotions, but it’s more common with deals that feature a limited-time 0% APR on purchases. I found that out personally with a store credit card once. Even with one dollar left of the original amount charged during the introductory period, one would likely owe back interest on the full $2,000 or more initially charged. Always pay off balances incurred during promotions before the introductory period expires. These 0% APR balance transfer deals are often great, but only if you abide strictly to the terms and take extra effort not to jeopardize your promotional rate.

I don’t know the rest of this reader’s financial situation, but given what was included in the note, my suggestion and my answer to the first question is to determine what payments are necessary to pay the $2,000 before the last bill is due in April 2012 and make that a priority. If the readers determines it would take $167 a month to pay the balance before the interest rate would increase, and if the cash flow is available, pay at least that much. Play it safe and get the balance paid off a little early, if possible. At the same time, pay the minimum or more to the car loan and student loan. When the student loan payments start in January, that will cut into your ability to pay off the car and the credit card. The reader can prepare for that by striving to pay off the credit card even faster.

Without knowing the reader’s cash flow, I wouldn’t be able to offer more specific suggestions.

Published or updated March 31, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 26 comments… read them below or add one }

avatar krantcents

My question is, can they do both? There will be additional loan payments starting in January. It would be optimum to pay off these loans before then.

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avatar skylog ♦368 (Nickel)

this is my question as well. i know we do not have all the information and the question was posted in a “this or that” scenario, but perhaps this would be the best solution. that said, if it was truly this or that, i would go with the credit card.

one, one could get rid of the risk of whatever the rate will be truly be once the 0% rate was gone, and if one did that and needed the card in an pinch, it would be there. not that using the card would be optimal, but it would be there.

regardless, the car rate will be lower.

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avatar shellye ♦107 (Cent)

I agree with krantcents in that they should try to pay off both loans before January. But if I had to choose one, I’d pay the credit card off first, while trying to refinance the car loan to a lower rate. 5.4% is outrageous. No doubt the credit card rate is going to be more than 5.4% when the year ends, and credit bureaus prefer installment debt (like car loans) to revolving debt (like credit cards) when determining credit scores, so it would benefit them in the long run to get the credit card paid off.

But if they can get both loans paid off before paying on a student loan, so much the better.

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avatar Steve

According to bankrate.com, auto loan refinance rates are 5.2% (in my state anyways.) Why do you think 5.4% is outrageous?

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avatar shellye ♦107 (Cent)

It’s outrageous because if their credit is decent, and they can join a credit union, many CUs are offering loans in the 2.99-4.50% rates, even for used cars. Obviously I don’t know their financial situation, or their credit scores, and maybe they have no idea what a credit union is. But if I’m trying to get stuff paid off, I’m looking to refinance any and everything to the lowest interest rate possible.

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avatar Pianist

Pay the Credit Card first. In case of emergency it’d be much easier to tap into available credit on the card vs. possibly taking a loan out using the car as collateral.

5.4% is far from outrageous. The only place you’re finding 0-2.99% financing is directly through the dealership. With this person owing only $3000 on the car, we’ll assume it’s an older vehicle. Refinancing at best would get him a rate in the 4% range and any loan origination fee (application fee) would offset any interest reduction. My suggestion: just send extra if you can.

I would love to see the Credit Unions offering these auto rates and then look at their savings rates @ .01%. There’s a margin they have to keep to make money.

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avatar shellye ♦107 (Cent)

Certainly, Pianist. Here are several credit unions in the Dallas area that not only offer 2.99% BUT whose savings rates are WELL above .01%. Check them out:

http://www.mmcu.com
http://www.lascolinasfcu.com
http://www.myncu.com
http://www.prestigecu.org

This is just a sampling of credit unions that pay higher interest rates on savings accounts and charge lower interest rates on loans of all types. And, yes, I’ve worked in this industry my entire adult life, so I could go on and on. They are almost universally better places to park your money than a bank, although I do use banks for certain things as well.

avatar TakeitEZ ♦549 (Dime)

I agree with the two previous posters. If paying both is possible its the best option of course. But if not, then pay the credit card first.

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avatar Steve

The retroactive interest usually only applies to store credit cards and loans (e.g. furniture, applicance loans). Balance transfers to general-purpose credit cards don’t typically have retroactive interest; I don’t think that’s even legal.

Still, I agree it would be best to ensure paying off the 0% credit card before it becomes due. You never know what they might do to your interest rate after the promotional period expires. You can plan on getting another balance transfer – assuming you’re still creditworthy…

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avatar Luke Landes ♦127,505 (Platinum)

Thanks for pointing that out. I clarified the post a little. The provision of the Credit CARD Act that restricts issuers from raising the rates on existing balances applies only to “fixed” rates, and credit cards now primarily feature “variable” rates. (Fixed rates always were kind of variable, because issuers could change them to a different “fixed” rate at will.)

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avatar wylerassociate ♦162 (Cent)

it depends on each person’s situation, I had to take out a 2 year loan a few years back and I paid it off in 6 months so I would pay the loan off first.

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avatar Paul

Thanks for the info. I will work on paying off that 0% card first.

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avatar Pat S.

Honestly, you can’t go wrong either way. If you have the capacity to pay off the interest bearing loan to leave enough time to pay off the card before the interest hike, then that would be my recommendation. Otherwise, I think your priorities are in the right place, and if you have made debt repayment a priority then you’ll be fine. Even if you end up paying a little extra interest in the end. If this is a long term change, then that’s the focus…

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avatar tigernicole86 ♦55 (Newbie)

I have to agree. The interest is here and now for the car loan. However, if they were to be lucky and pay that off early, they could keep paying what they would normally to the credit card. Remember, with the credit card they can charge you more interest but with the car, they can take that away after a while…

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avatar Shawanda

I’d shoot for getting the credit card debt paid off first. It’s best to limit your exposure to their whims. As a group, I just don’t trust them. And who knows what sneaky little tricks they have up their sleeves. Although he’ll continue to incur interest on the car loan, he knows, for sure, that the rate won’t change.

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avatar pfninja ♦256 (Nickel)

If they continue to pay the minimum on the credit card they will owe approximately $1,430 when the interest rate jumps to 10% (assuming 3% monthly payment)

Paying the car off in one year @ 5.4% would require approximately $257 monthly. Over that time period they will pay $88.47 in interest.

Apply the $257 towards the $1,430 and you’ll have paid it off in 6 months with $40.48 paid in interest. I’d say $120 in interest over 18mos for $5K in debt isn’t too bad at all.

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avatar Paul

Thanks for this insight. It really helps. :)

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avatar Cejay ♦1,521 (Half-Dollar)

Both if they can live on a shoe string for a year and if not then the credit card. I would hate to have to pay all the back interest on this loan. I have to say that I really HATE these types of credit cards since a large majority of people, at least the people that I know, forget about them until day 366 and then you owe it all.

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avatar cubiclegeoff ♦896 (Dime)

Seems like Flexo’s method makes the most sense. Pay off the credit card over the period left and any extra goes to the car.

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avatar Josh

Depending on the interest rate on the student loans (if they’re federal, I bet 6.8%), it may make more sense to make some student loan payments before the loans get into repayment as opposed to making extra car loan payments. If you have unsubsidized loans, you want to make the payments on those, as they are currently accruing interest that will be capitalized when the loans go into repayment. No matter what, the 0% credit card needs to be zeroed out by next April.

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avatar Ceecee ♦53 (Newbie)

As always with loans, the devil is in the details. Yes, a lot of those 0% interest intro rates charge on all past money borrowed if they are not paid off in time. Sounds like it would be good to pay that off first.

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avatar lynn ♦155 (Cent)

I’ve just found this site today, but I am already impressed with it. I hear a lot about leaveraging and run far away when I do. The stable and concrete way of managing money has always worked. I’m glad to see you are not in the business of reinventing the formula.

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avatar No Debts, No Regrets

I would pay the credit card first, especially if there is little or no emergency fund, its always something you can fall back on. Due to illness and then unemployment, I accummulated a large amount of debt. I have been able to pay off about 30% of it so far. One of the ways I did this was to create what I call the Debt Buster spreadsheet. I have posted it on my blog where anybody can download it for free. I will also help anybody who needs it on how to use it. Just post a question and I’ll answer it as soon as possible.

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avatar 4hendricks ♦248 (Cent)

Credit card first, at least the car payment is fixed – then pay off the car – then the student loans. Oh and don’t forget to not run up the credit card balance again – pay it off in full each month.

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avatar Abby Freedman ♦137 (Cent)

I agree that it depends on what their situation is financially. My knee-jerk reaction would be to pay off the loan first. Then again I’ve never had a 0% card that charged interest based on the whole amount.

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avatar Kristina ♦141 (Cent)

If I was in their situation and could swing it financially I would aim to pay off the cc debt before the new debt comes into repayment in January, then focus on what ever will accrue the most interest beginning in January. It might be the student loans but getting rid of the car means freeing up money faster, when the student loans are going to take years, depending upon their loan amounts.

If I could pay off the cc debt before January then I would tackle as much of the car debt as possible but with out sure dollar amounts of loans and cash available every month it is hard to make a true recommendation.

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