Pay Off Credit Card Vs. Car Note

Owning your vehicle free and clear versus freedom from a credit card bill: Both sound good. However, there may be financial and personal advantages and disadvantages to paying off one rather than the other that you've never considered. For example, one loan helps your credit more than the other, but the other may have a lower interest rate. Remember the golden rule of debt payoff: Paying high interest loans first saves the most money and is the quickest route to debt freedom.

Paying Your Auto Loan: Pros

There's no question, cars are expensive. Your car is a depreciating asset that plunges in value the second you drive it off the lot. Paying several hundred dollars a month for a vehicle that may be four, five or even six years old feels painful. Your auto insurance may also be higher if your lender requires that you carry collision coverage. Also, if you are concerned about your budget, knowing your car is paid for in full will give you peace of mind about repossession.

Paying Your Auto Loan: Cons

Unquestionably, there are appealing reasons to pay off your car loan first. However, consider that auto loans frequently have low interest rates, often as small as 1 or 2 percent. Also, an auto loan is a quality loan that credit bureaus consider when calculating your FICO score. (Home loans are the best, auto loans are next, and credit cards are last.) Paying your auto loan back as agreed will help your credit more than paying it back in a lump sum.

Paying Your Credit Card: Pros

The advantages to paying off your credit card debt in full cannot be overstated. Although many credit cards offer balance transfer offers with rates as low as zero percent for a six- or twelve-month period, issuers may raise your rate at any time, for any reason, especially if a lender decides your borrowing profile has become too risky. Standard rates can be as high as 20 percent, so every dollar paid off is equal to getting that percentage return on your money.

In addition, credit card balances that are more than 50 percent of your credit line have a negative affect on your credit score. Responsible use of credit cards is one of the top items that lenders -- especially mortgage lenders -- analyze when determining what sort of risk you present as a borrower.

Credit Card Cons

If you are financially responsible, have excellent credit, have a balance that is less than half of your credit line, and are paying a low interest rate, then plan to pay your higher interest balance first. For example, if you are paying 6 percent on a car loan but zero percent on a balance transfer for the next 12 months, you may put as much as possible toward the car loan over that 12-month period.

For this plan to work effectively, you should be able to pay your credit card balance in full prior to the end of the interest-free grace period. If you cannot but still want to pay your auto loan first, simply add the auto payment to the credit card payment once the car is paid in full.

Whatever method you choose, use a free online debt reduction calculator to compare your choices, and honestly evaluate what you believe your spending habits will be during your repayment period.