Many Americans unfortunately face the same dilemma every month of what bills to pay with a limited amount of money — but the way many decide to prioritize those debts may actually be costly.
In fact, consumers in financial distress tend to prioritize unsecured personal loans ahead of other credit products such as auto loans, mortgages and credit cards, according to a new TransUnion study. The desire to pay off such loans may come from the "quick win" borrowers feel with these loans, as there is a near-term end to the debt.
"It is quite surprising to us that, for most struggling consumers, unsecured personal loan payments are prioritized over other prominent credit products such as mortgages and auto loans," said Ezra Becker, senior vice president and head of research for TransUnion's financial services business unit.
However, the short-term fulfillment of paying off a personal loan first could come at the cost of a person's car or house, experts warn.
"Secured debt repayments should be the first bills paid in every household, so I am alarmed by the findings in TransUnion's recent study," says Natasha Rachel Smith, a personal finance expert at TopCashback.com.
"There is a notable difference between secured and unsecured loans," Smith adds. "Secured loans, which include borrowing money for mortgages and car financing, offer low interest rates and longer repayment terms in exchange for giving the lender security that you will definitely repay the debt."
Of course, if the repayment doesn't happen, the lender can repossess the asset, such as a home or vehicle.
"Unsecured borrowing, such as credit card balances and regular loans, aren't linked to collateral, hence why they have high interest rates," Smith said. "Since there is no property or asset to repossess and sell in the case of a default, the interest rate is the only benefit to the lender."
Failure to repay any debt will negatively affect your credit score, but failure to repay a secured debt could also mean you lose your home or vehicle. "That's why you always, always, make repaying secured debt the priority," she adds.
The fact that consumers may prefer to make payments on debts with relatively shorter terms — such as personal loans — is understandable, but ultimately incorrect, adds Kevin Gallegos, vice president of Phoenix operations for Freedom Financial Network.
"Consumers need to look at the bigger picture," Gallegos said. "Always pay the minimum on secured debts."
Gallegos agrees consumers sometimes make bad decisions paying off bills, because the "snowball" method of paying debt — paying off the smallest debt amount first — is so much more attractive than the "avalanche" method — paying off debts by starting with the one with the highest interest rate.
"Often, the 'snowball' method of debt payoff is more popular, as it helps motivate people to stick to the plan of paying down all debts," said Gallegos, but adding in the long run, the consumer pays more interest, so it's much less cost effective.
"In my interactions with clients, I can tell you clients 100% have misplaced priorities when it comes to paying down debt," said Amy Westbrook, a money coach for Capital One. "I have seen clients contributing to retirement accounts earning maybe 8% while carrying credit card debt at 22%. I have also seen a few clients take out a personal loan — the ugly kind with 30 plus percent interest rates — to pay down credit cards with rates from 12% to 22%."
Westbrook adds one of the biggest problems with debt and consumers paying bills is that so many are disconnected with their values when it comes to spending.
"If people could prioritize their spending with what they truly value they could avoid accruing higher levels of debt," Westbrook said.
If someone runs into real trouble paying bills, Gallegos reminds some debt almost is never forgiven — so don't think it can be avoided.
"Student loan debt never goes away," he said. "Even in a bankruptcy, it cannot be discharged. Make the required monthly payments on student loans, while putting extra money toward other debt, including credit card debt."