By AnnaMaria Andriotis
Question: I have $17,000 in credit card debt at a variable rate of 10.99%, which I plan to pay off using my monthly income by December 30. I have a $15,000 car loan at 2.65% fixed with 4.5 years left to pay on it, which I was not planning to pay off prior to the loan term date. I am receiving a $7,000 after-tax bonus in September. Should I use this to pay down the car loan or use it to pay down the credit card?
Answer: Congratulations. You now have an extra option to deal with your financial woes. And in your case, $7,000 will come in handy.
With such a high rate on your credit card, this debt is the more dangerous of the two. It’s also sucking up a lot of your income. To pay off $17,000 by December at 10.99%, you’d need to pay $3,494 each month. Use your bonus to cut that debt, and you’ll slash the balance to $10,000, and cut your monthly payments by about $1,440 – money that you can then put to work elsewhere, like paying down your car loan or cushioning your savings account for a rainy day. (If you don’t have an emergency fund yet, you might divert some of your bonus there first to protect against further debt, says Sheryl Garrett, a fee-only certified financial planner.)
As for your car loan, what you have here is a fairly good deal. The average rate on common car loans right now is around 5.5% and rising, according to Bankrate.com. That, plus the fact that you have a fixed rate, makes your car loan among the cheapest. And that also makes paying it down quickly less pressing.
Looking forward, a few hypothetical scenarios also suggest that paying the credit card with this bonus is the way to go. In case you run into hard times, you’ll have a larger credit line to pay for the essentials. You won’t be able to lean on a car loan for that. And, given the U.S.’s downgrade last week, analysts say that credit card interest rates could soon rise, even on existing balances. That’s a scenario you’d want to avoid, and this bonus will do that for you.