Faculty Research: Consumers Typically Prepay Old Debts First, Regardless of Interest Costs

How do consumers decide which loans to prepay when they have extra funds? 

That’s the question Alicia M. Johnson, assistant professor of marketing at the Isenberg School of Management at UMass Amherst, explores in research published recently in the Journal of Marketing Research.

The answer, it turns out, is that people often focus on prepaying their oldest loans, regardless of whether that makes the most sense financially.

“In our studies, we find that consumers prioritize older debt prepayment because they feel they have invested greater effort—including mental or physical work and energy—to repay it,” Johnson said. 

She and her coauthors decided to explore the question because more consumers are turning to installment loans (such as personal; buy now, pay later; and car loans) to cover their expenses. These loans have clear repayment schedules with starting and ending dates, and while consumers should consider specific account parameters (interest rate, monthly payment, etc.) when making debt prepayment decisions, in many circumstances it makes financial sense to prioritize paying down newer debt, Johnson said. “This is because debt amortization (i.e., repayment) schedules often result in reduced interest payments when newer installment debts are paid first.”

But many people don’t make the effort to figure out if they would benefit from prepaying their loans in a different order than they took on the loans. 

“It is fairly simple to run the numbers and see what the best financial choice is,” Johnson said. “However, it can feel counterintuitive to allocate funds to newer instead of older debt, even when it’s financially optimal to do so.” 

Johnson’s interest in personal finance was sparked early in her career, when she spent time working as a loan officer. “I saw consumers make financially suboptimal decisions all the time,” she said. “The desire to understand why these decisions were being made is what led me to pursue my PhD in the first place and now informs my research interests around debt repayment.” She also admits that she can’t recall whether she herself prepaid past installment loans based on debt age. “It just goes to show how even those of us who know and love personal finance may not be aware of the suboptimal choices we may be making.” 

Optimizing Loan Payment Strategies

Johnson shared some simple tips:

• Focus on interest savings: Before making a payment, calculate which loan will save you the most interest if paid down first.
• Reframe your thinking: Instead of “how long I’ve had this loan,” think “how much time is left.” Loans with more time remaining usually cost more in interest.
• Use financial tools: Many apps and bank platforms can show real-time interest savings for different payment scenarios.