Who To Pay First When You Owe Money

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Saturday, February 28th, 2009 Subscribe To Our Feed

When you go into deep debt, climbing out of it can be extremely difficult. The chief factors that make it hard are the many penalties you incur as a byproduct of not paying your bills on time. Firstly, you’ll find it harder to get credit, and if you do get credit, you’ll pay a greater interest rate for it. In addition, late fees do nothing but add debt onto your already exploding bills. You’re constantly harassed by lenders threatening legal action if you don’t pay. But you can’t afford to pay all of your loans, so which ones do you choose first?

When a lender loans you money against an asset, the understanding is that if you are unable to repay the loan, for any reason, then the lender will assume ownership of that asset. In lending arrangements, this kind of loan is referred to as a secured loan or an asset loan, and the asset that you put up is referred to as collateral. The collateral is the lender’s way of making sure that you have an incentive to pay back the money that you have borrowed. Once you pay off the loan, however, the lender no longer has any rights to your asset.

If you borrow money without putting up an asset as collateral, you have made an unsecured loan. In this case, if you default on the loan, the borrower cannot legally take any assets of yours. If he wants his money back, his only options are to sue you for the borrowed money or to continually harass you until you repay the loan.

Many people, will feel pressure to first pay off the loan from wherever they are getting the most pressure from. But in many cases that would be a mistake. When looking for a solution to how to get out of hopeless debt, in most cases the secured loans are the ones that you should pay off first. Lenders that have given you a secured loan know that if you don’t pay your debt they can simply take back their collateral.

For example, if you have an unsecured loan, your lenders will have an unusually difficult time and limited means of getting their funds back. Credit cards are the most prevalent type of unsecured loans. When you are issued a credit card, you are issued it on the strength of your credit alone. No assets are involved. If you miss a credit card payment, you are charged a late fee which is added on to your next statement. Thus, you are penalized, but you haven’t loss any assets. If you miss too many payments, the credit card company will likely suspend your credit card but you still haven’t loss any assets.

On the other hand, a house or real estate, is one of the biggest types of secured loans that banks offer. They know that if you forfeit your loan payments, they can simply take their property back. So, if you miss more than a few mortgage payments, your mortgage company or lender is likely to start foreclosure proceedings against you that will eventually end up with your eviction and the loss of one of your biggest assets - your home.

A car loan is another type of secured loan. If you are a few payment behind on your car payments, the lending company may repossess the car. If you need your car to get to work, you additionally could have difficulties earning a living. Again, because of the loss of an asset.

For these reasons, all things being equal, if you are behind in payments, you should make payments toward your secured loans first.

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