Choosing How to Allocate Loan Payments: The Repayment Pyramid

How to choose where to allocate loan payments: 

A “Repayment pyramid” refers to paying off the smallest loans first. Similar to consolidation, the fewer separate payments you have, the more flexibility you will have in choosing how your money is allocated each month. This can be achieved faster by paying off the smallest loans first and working your way toward the biggest loans.

If you have a $10K loan that has $100 monthly payments and a $40K loan that has $500 monthly payments, you may be tempted to want to put the bulk of your money toward the larger loan, as you see it as the biggest monster you are fighting. Resist! Pay off that $10K loan first, and when it’s gone, you suddenly have the option of only paying a $500 minimum, instead of $600 minimum, per month. You should still pay as much as possible, but it gives you flexibility to do what’s best for you for that month.

Now, you also need to make smart decisions based on interest rates. If you have a loan for $10K at 6% interest, and another loan for $10K at 8% interest, it makes sense to pay off the higher interest rate loan first. Applied to the loan pyramid, you may still want to pay off higher interest rate loans first, even if they are larger principal loans. Take into account:

  • Loan principal
  • Interest rate
  • Likelihood that you can continue to make the same payments each month until the loan is paid off (if you think there is a risk that you are going to be able to pay less in the future, add that as part of the equation to maybe wanting to get the number of payments reduced, i.e. paying off smaller loans first).

 

Take the loan repayment pyramid into account when you are consolidating your loans. If you have 3 loans at 6% interest and one at 9% interest, but at a much smaller principal, does it make sense then to consolidate the three, focus on paying off the one with a higher interest rate first, and then working on the 3 with a smaller, more manageable minimum payment? These are the questions to mull over under your own circumstance.

Of course – this all becomes easier when you are making more money and have more expendable money to throw at the loan. Find out more about this here.

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