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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Debt Management and Loans

A client with several high-cost debts asks how to prioritise prepayment when she has a small surplus. Which approach is most consistent with sound debt management?

The client should prepay the debt with the highest effective interest rate first, such as credit card dues, because this saves the most interest. Choosing by balance alone, favouring the cheapest loan, or skipping minimum payments increases cost or causes penalties and credit score damage.

  1. APrepay the debt with the highest effective interest rate first, such as credit card duesCorrect
  2. BPrepay the loan with the smallest outstanding balance regardless of rate
  3. CPrepay the lowest-rate home loan first for the tax benefit alone
  4. DStop paying minimum dues on all loans and pay one loan fully

Explanation

Prepaying the costliest debt saves the most interest, and credit card dues usually carry very high rates. Choosing by balance size alone ignores cost. Prepaying the cheapest loan merely for tax benefit is generally inefficient, and skipping minimum dues causes penalties and credit score damage.

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