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Which to tackle first: car loan or student loan?

September 24, 2012: 6:30 AM ET

I have an auto loan (a balance of $22,000 with an interest rate of 2.69%) and a student loan ($6,500 at a 3% rate). If I put extra money each month towards one of these loans, which should it be? — Andrea V.

On a purely mathematical basis, you're better off focusing your efforts on first paying off the loan with the highest interest rate. Over time, that strategy will save you the most money because you won't be spending so much on interest payments. On a psychological basis, that may not necessarily be true; personal finance guru Dave Ramsey, for example, argues that paying off the smallest debt first, by giving you a quick victory in the debt-elimination process, better motivates you to pay off all your loans.

In your case, the higher-interest debt and the lower-balance debt are the same one, making the decision easy: Direct your extra payments to paying down the student loan with the 3% interest rate. "While the rate difference between the two isn't huge, it has the higher interest rate and you'll get the satisfaction of having one bill paid off," says Neil Collins of Collins Financial Advisors in Melrose, Mass.

That said, Collins notes that both loans have very favorable rates, and suggests considering other ways to use the extra cash in your budget. For instance, boosting your contributions to retirement savings accounts such as your 401(k) or IRA may provide more bang for your buck than accelerating payments on your student loan or car loan. "At the very least, make sure you're saving the minimum to take advantage of any 401(k) match," he says. "And if you have a little extra, you can put it in an IRA or a Roth IRA."

— Austin Kilham

Got a question for the Help Desk? Send it to helpdesk@cnnmoney.com.

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