A reader recently posed a question to Farnoosh Torabi, who writes a column for Yahoo Finance, about making extra payments on loans. His question was whether he should focus on a high-interest personal loan, even though he wouldn’t be building any equity, or low-interest mortgage and car payments.
Torabi’s advice is about what one would expect.
“A personal loan, while unsecured, does help to build a unique type of equity we often don’t think about: your financial security,” she noted.” The earlier you pay off that loan, the earlier you’ll be able to raise your personal equity, won’t you?”
Torabi went on to say that the reader’s “emotions [were] taking over.” The money saved by paying off the high-interest loan could be used to reduce the remaining balances on the other loans.
This lesson is one that should be evident to every borrower. But these are the types of questions that people seeking loans ask themselves all the time. Those who have limited spending power have to constantly make judgments about which lines of credit to pay off and which to allow debt to accrue. All debt is a threat to borrowers’ credit scores, but they may need to be selective about where debt mounts.
Lenders need to know which borrowers are at greater risk of default, and the best way to make this determination is through the use of risk assessment tools that can be customized to the needs of a particular lender. For some, being able to assess the “Five Cs of Credit” is sufficient, but for others, there may be other metrics of interest to them.