Experts say paying off your unsecured personal loan is hurting you
A major credit bureau is surprised by our priorities when it comes to paying down debt.
A new study from TransUnion says we’re paying off unsecured personal loans faster than auto loans, mortgages, and credit cards. Mortgages and auto loans are both secured — meaning if we don’t pay them, we lose stuff. Our houses and cars.
Credit cards, like personal loans, are unsecured. They still affect our credit rating, but won’t do as much damage if we fall behind. Personal loans aren’t for a specific purpose. Other types of unsecured loans — like student loans — are.
TransUnion guesses we prioritize personal loans because they have the shortest timeframe, around 28 months. Meanwhile, auto loans, mortgages, and credit cards (which are open-ended) tend to last many years.
This is the first time in its seven-year history that the TransUnion Payment Hierarchy Study included unsecured personal loans. Prior to these findings, auto loans were usually the top priority, over mortgages and credit cards.
“While personal loans have existed for a long time, recent growth in the number of such loans led us to explore this product’s position along the payment spectrum. The prioritization of personal loan payments above all others is counterintuitive,” says TransUnion executive Ezra Becker. “It is quite surprising to us that, for most struggling consumers, unsecured personal loan payments are prioritized over other prominent credit products such as mortgages and auto loans.”
Because personal loans have shorter terms, consumers feel obligated to pay them off sooner — and freer once they’re fully dealt with. TransUnion says auto loans were previously on top because they, too, had a shorter term than mortgages. Credit cards were always last, with one brief exception. When the housing market crashed in 2007, homeowners were underwater on their mortgages, and owed more on their homes than they were worth. With unemployment on the rise and mortgages having longer terms, homeowners began to concentrate on their credit card payments.
“The payment hierarchy is complex—the decision process for struggling borrowers is a difficult one… both the strength of the labor market and housing values continue to be critical drivers of that decision process,” Becker says. “Barring another such trauma to the consumer credit market, we believe financially constrained borrowers will tend to pay their personal loans, auto loans, mortgages and credit cards in that order.”
The most important debt to pay off right now
The most important debt isn’t always the same for everyone. However, you should usually try to prioritize the debt with the highest interest rate rather than the one with the shortest deadline. Sometimes that’s an unsecured personal loan, but many times, that’s your credit card — the credit card you’re probably only making minimum payments on until now.
That’s after your mortgage payments, if you have one. But while your mortgage isn’t going anywhere and you need your car to get around, look to paying as much of your credit card off as possible. Every month you carry a balance, you get a finance charge applied to your account. These can add up quickly and if you’re only making minimum payments each month, you may only be paying that interest and not the principle. To avoid that, put as much of your available cash toward outstanding credit card payments.
Article last modified on June 26, 2017. Published by Debt.com, LLC . Mobile users may also access the AMP Version: Are You Paying the Wrong Debt First? - AMP.