Which debt to pay down first?

We are often approached by individuals overloaded with personal debts asking us how to handle this debt. Which debts should be paid down first? How to prioritize debt repayment without going into arrears? Naturally there is no single solution to suit all. You will need to consider personal circumstances before making any decision.

Difference between Secured and Unsecured debts

Secured debts are loans that are secured by an asset. These can include your car loan, home loan or a property investment loan. Such loans are usually offered o a lower interest rate than unsecured loans as they are seen as being less risky for the lender. If the borrower stops paying these loans lenders are usually able to repossess the security asset (within a defined period of time) and sell it in order to recoup their losses.

Unsecured debts include unsecured personal loans, credit cards and store cards to name a few. These products tend to be more expensive as they are a higher risk product for the lender. If the borrower stops paying these products, lender has nothing to repossess and sell. They can however still pursue the borrower in courts, damage their credit history and even possibly cause their bankruptcy. If the borrower is a home owner or has other assets these could still be sold up by the bankruptcy trustee if in fact you fail to make good your unsecured debts and are forced into bankruptcy.

The above comparison indicates that while it may be reasonable to prioritize the repayment of secured debts over unsecured ones, as a borrower we can not afford to ignore any of our debts.

Unsecured debt problems

Borrowers with unsecured debt problems have a number of strategies at their disposal. They should first establish if their unsecured debts are in fact affordable to them or are the debts sufficiently significant to effectively force the borrower into insolvency. Insolvent borrowers do not necessarily need to resort to bankruptcy. They may be able to negotiate debt repayments informally with creditors in order to temporarily reduce set repayments. For a more permanent debt problem, a formal debt agreement could be signed  with creditors to reduce the pressure of unaffordable debts.

While these lenders are not able to take assets away from you for the non-payment of debts, they are able to create a lot of damage to your credit history and ability to borrow in the future. Therefore unaffordable unsecured debts need to be actioned as a matter of priority.

Secured debt problems

Secured lenders can repossess a asset in the event of non-payment. Borrowers who are having trouble with these loans need to contact their lenders in the first instance and request a hardship arrangement or a repayment holiday while they either find a new job, get help from family or possibly decide to sell the asset in their own right rather than have it repossessed. Some people do not realize that in most cases a repossession will cost you more and damage your credit history more than if you sold the asset yourself to repay the debts.

Some of the other popular strategies used to reduce secured debt repayments are extending the term of the loan to reduce repayments or moving from principal and interest to interest only for a period of time.