Home budget problem – harder than should be! Assist?

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Home budget problem – harder than should be! Assist?

Question: Loan A has a total interest payment of $100/month, while Loan B’s > interest payment is $200/month. If you pay Loan B first (the loan > with the largest dollar interest), you will, after one month, find > that Loan B has a balance of $1980 (you payed $200 interest, plus > $20 principal), while Loan A’s balance has grown to $200 (you > accumulated $100 in interest and made no payment). Next month, you > will owe $398 in interest ($200 from Loan A and $198 from Loan B). > You will not be able to cover the interest, let alone pay off any > principal. You will be in a hole from which you can never recover. > On the other hand, if you were to first pay $200 toward Loan A ($100 > in interest for the month, plus $100 in principal), and the additional > $20 toward loan B, you would find that, at the end of the first month > you have a balance of 0 on Loan A and $2180 on Loan B ($200 accumulated > interest, less $20 payment). Your next monthly interest payment is > $218, which leaves $2 for principal reduction, and you are on your > way to a normal payoff.

Answer: Your example incorrectly assumes that the base payment is not being made on each loan. The original question was regarding ADDITIONAL payments, not all payments. It was regarding which loan is better to pay off first. This assumed that all additional money paid was paid off principal.

I tried a different example and surprised myself.

Loan 1: $10,000 at 25% for 3 years. Loan 2: $50,000 at 10% for 30 years.

This makes monthly payments of $397.60 for loan 1, and $438.79 for loan 2. Total interest is $4313 for loan 1, and $107964 for loan 2.

Let’s say that you have an additional $500.00/month to pay on the loans.

I was quite sure that paying the extra $500 on loan 2 would be better, but I was wrong. Paying on loan 1 first took 68 months to clear both loans, paying loan 2 first took 70 months. So in this case, paying on loan 1 first would save about $2672.

This confused me because I had figured this for my own loans, and I saved about $5000 by paying the long term loan first. Going back to look at this I realized that the difference was that on my long term loan, the interest was re-calculated monthly.

This leads me to ask the question the original poster asked. Other than manually figuring out the specific numbers for a specific case, is there some simple method to figure this out on a more general basis? I still do not buy the idea that interest rate always wins.

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Home budget problem – harder than should be! Assist?

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