Pay-off Car Loan or Pay-down Mortgage?

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fnmix
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Pay-off Car Loan or Pay-down Mortgage?

Post by fnmix » Tue Dec 08, 2015 7:38 pm

Hello,

I am mid-way through my current savings goal of $100K in 529s for my two pre-school aged kids. I am close enough to achieving this goal that I am having to think of the next saving goal. In particular, I am trying to decide if I should pay-off my car loan before paying down my mortgage.

Details
  • Minimum retirement savings goal already accomplished. Creating a decent sized 529 was my next goal after the retirement savings goal.
  • I have a single income family and it will stay that way for the foreseeable future.
  • I have a car loan of ~$17K (amount remaining, loan at ~1% interest rate) which pays off in 2.5 years if I don't put down additional payments.
  • I have a mortgage of ~$163K (remaining amount, loan at 2.9% interest rate) which pays off in 7 years if I don't put down additional payments.
  • I am 43 and expect to change careers in 7 years. Very likely my earning power in this new career will be much lower than what I make now.
  • My overarching goal is to situate myself as well as I can when I transition to the lower paying career. I do expect that this career will cover my family's monthly expenses for several more years, but may not leave too much for 529 or retirement savings.

By the time I get done with my 529 savings goal (via some bonus/employer-stock windfalls in the next few months), I expect that between $10K and $14K will be left on my car loan. Paying the car loan off obviously decreases my monthly expenses (by about $575) which is attractive. On the other hand if I pay down the house instead, it brings the house pay-off date closer (but still ~6.5 years away) giving me some wiggle room before I transition to a new career.

I am looking for recommendations/rationale on which goal to pick.
What would you do in my situation?
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peterinjapan
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by peterinjapan » Tue Dec 08, 2015 8:12 pm

Wow, I haven't had a car payment in years, and would hate a $500+ one. I blessedly live in Japan, a country that allows any car to be purchased through a corporation, so my company buys all my cars.

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Watty
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by Watty » Tue Dec 08, 2015 8:48 pm

I would pay off the car loan first and then start saving up to pay cash for my next car before I would pay down the mortgage.

The reason is that even though the car loan is only about a tenth of your mortgage balance but the car loan payment is likely nearly as big as a mortgage payment could be so not having a car payment greatly improves your cash flow and that will help when you change careers.

Car loan rates are low right now but they may not be when you need to refinance your next car.

harrys
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by harrys » Tue Dec 08, 2015 11:08 pm

The rule of thumb is to pay off the loan with the highest interest rate first. The auto loan is ridiculously low & it's tempting to just let it play itself out. The house...if the interest rate can be reduced you may profit by renegotiating it to capture the deductible interest that would be front-loaded (assuming you can do this with minimal expense) & as soon as you get to a point of paying principle only - just pay it off. Your goal of entering your new life phase debt-free should be easy to realize.

Stockpiling as much cash as possible so that you enter your new career with a hefty reserve is a good goal. Interest rates are likely to increase in the future & if they do there may be a point when it becomes more profitable to put your money into savings rather than debt reduction.

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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by dharrythomas » Wed Dec 09, 2015 12:04 am

I'd use the Dave Ramsey "debt snowball" approach. Pay off the car loan, then move the car and payment and the additional payment to the house at least until you can the pay off date on the house before you switch careers.

Not having any payments when you transition will lower your stress considerably.

Good luck.

Harry

grettman
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by grettman » Wed Dec 09, 2015 8:12 am

I can't imagine hanging on to non-mortgage debt while at the same time talk about saving/investing.

Just a couple of caveats:

Unless there is an opportunity to get a match from an employer for contributing to a 401K
Establishing an emergency fund.

..but that is just me. I am debt adverse.

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knpstr
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by knpstr » Wed Dec 09, 2015 8:19 am

car first
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

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fnmix
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by fnmix » Wed Dec 09, 2015 9:17 am

Hi All,

Thanks for your comments.

I came to the conclusion that I will pay off the car loan at the earliest opportunity - as much for some psychological benefit (one less complication in life and one less entity that I owe money to) as for a logical reason (debt-snowball approach, improving cash flow).

One new thing I learned in this thread: I didn't think it was possible to renegotiate the terms of the mortgage while making payments (without going through a refinance). Worth a try. And frankly I wish I had thought of this while previously making lump-sum payments to lender (who has in-turn sold the loan to Freddie Mac).

Thanks again everybody.
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by NoVa Lurker » Wed Dec 09, 2015 9:28 am

I don't necessarily disagree with any of the advice above, but 2.9% on the home loan is not that bad. Your time has value too, and I wouldn't devote a ton of effort to trying to get that 2.9% down to (for example) 2.625%, when you only have 7 years left on it (and maybe less, if you prepay a bit).

I am as debt averse as the next boglehead, but $163k at 2.9% for a home mortgage and $17k at 1% for a car loan sounds pretty reasonable to me. I mean, if you said $180k for the home mortgage, nobody would question it.

I would have voted to pay down the 2.9% loan ahead of the 1% loan, just because the 2.9% interest rate is more expensive. But it doesn't matter much in your situation, and it will be nice for you to have the extra cash flow once you have no car payment.

Anyway, good luck, it seems like you are in good shape with your goals either way.

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JupiterJones
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by JupiterJones » Wed Dec 09, 2015 9:31 am

harrys wrote:The rule of thumb is to pay off the loan with the highest interest rate first.


I say that was just "a" rule of thumb. As others have posted, there are other thumbs. :D

Also in favor of the "pay down the car" method: It typically makes much more sense to pay down a depreciating asset over a (most likely) appreciating one.
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quantAndHold
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by quantAndHold » Wed Dec 09, 2015 9:57 am

To be a contrary voice, both of your interest rates are low. You don't say how you have your savings invested, but I would assume you're earning more than a 1% return, and possibly more than 2.9%. You might consider just continuing to make payments on the loans and invest the extra money, especially on the car loan. I understand the psychological benefits of paying stuff off through. We just paid off a house that was at a low interest rate and would have been paid off when I retire in two years anyway. The quant in me said to keep the loan and invest the money, but we paid it off anyway.

But it sounds like you're in good shape whatever you do. Congrats!.

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BolderBoy
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by BolderBoy » Wed Dec 09, 2015 11:08 am

I didn't see what marginal tax bracket you are in, but I'm guessing that paying off the car first is a better strategy in the short term, as suggested by the other posters.
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Dulocracy
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by Dulocracy » Wed Dec 09, 2015 1:25 pm

First, the OP does not really need the Dave Ramsey snowball method. That method is for those who cannot manage to save/pay down debt on their own, and they need an emotional boost. Rather than taking the method that is most financially beneficial, they take the option that makes it more likely that they stick with the plan. For them, that is actually the correct decision. For the OP, however, who already saves and pays down debts, it is not the best option. Paying the highest interest would be the best option.

Even presuming a 50% deduction in a very high tax rate, 1.45% for the mortgage is more than 1% on the car. Heck, inflation pretty much takes care of the car interest rate. (NOTE: an exception to this would be that if the OP is so close to the next income bracket that the mortgage interest deduction makes a difference in which income bracket one finds himself/herself.)

Unless the OP has cash flow issues, OP would be better off financially in the long run paying the mortgage down.

As to whether or not you should pay a depreciating asset off first: the asset is irrelevant. If that was a rule, you would pay off a 0% car note before paying a 7.5% mortgage, and we know that simply is not the correct answer. The answer is that whichever is better financially is the one that is better financially. I understand the emotions of not wanting to owe more than a thing is worth, but that really has no impact on a decision as to what is best financially. In fact...

If the car is torched at a wild party or if the house is swallowed up by the earth, the debt is still owed on either one. Because the mortgage would mean losing the asset that is appreciating in value in the event of a foreclosure, it would actually be better to pay off the appreciating asset to protect the more valuable holding.

In reality, the interest difference is so small and for such a short period of time that we really are not talking about a huge amount of difference one way or the other. It is better from a financial standpoint and an asset protection standpoint to pay off the mortgage, but OP seems to be doing well whichever way OP goes.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.

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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by grabiner » Wed Dec 09, 2015 9:50 pm

Dulocracy wrote:Even presuming a 50% deduction in a very high tax rate, 1.45% for the mortgage is more than 1% on the car. Heck, inflation pretty much takes care of the car interest rate. (NOTE: an exception to this would be that if the OP is so close to the next income bracket that the mortgage interest deduction makes a difference in which income bracket one finds himself/herself.)


This wouldn't matter much either; the higher tax rate applies only to the amount in the higher bracket. If you are $1000 below the top of the 15% bracket and you lose a $2000 mortgage deduction, you pay 15% tax on $1000 and 25% tax on $1000, so the net cost is only 20%.

There is one reason why you might want to pay off the car: paying it off may allow you to increase your insurance deductibles, which will save you more money than just the interest. (Similarly, while this probably doesn't apply to you, some homeowners have an extra incentive to pay down their mortgages, in order to get rid of PMI, or get enough equity to refinance the mortgage at a lower rate.)
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JupiterJones
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by JupiterJones » Thu Dec 10, 2015 11:14 am

Dulocracy wrote:First, the OP does not really need the Dave Ramsey snowball method. That method is for those who cannot manage to save/pay down debt on their own, and they need an emotional boost. Rather than taking the method that is most financially beneficial, they take the option that makes it more likely that they stick with the plan.


Yes, it does give you "quick wins" which can be motivating. But that doesn't mean that it's only for people who wouldn't stick with the plan otherwise. It can makes sense even for highly self-motivated individuals too.

And that's because the method that is "most financially beneficial" depends on your definition of the terms. If, by "financially beneficial", you mean "minimizes total interest paid and time to pay off", then the highest-interest-first method does indeed win.

But if you define it as "frees up some amount of discretionary income the fastest", then the debt snowball wins. That's a perfectly valid metric to use too, and the difference in total interest paid can very well be worth the price for the benefit (and it is a benefit) of increased cash flow.

I often use the analogy of a plane taking off. The pilot can choose different takeoff angles (or speeds, really--they're basically the same thing). The one that typically gets chosen is not the one that necessarily minimizes fuel costs or travel time. It's the one that gets as much distance between the plane and the ground as fast as possible, thus minimizing risk. In the event of anything going wrong, your altitude is your margin-of-safety. Obviously, reducing risk trumps reducing costs and time when it comes to plane travel!

Same with the debt snowball. It doesn't necessarily save you the most money or time, but it does minimize risk. In the event of anything going wrong (job loss, health emergency, etc)., the fewer number of bills you're on the hook for, the higher your "altitude"--your margin-of-safety. Whether reducing risk trumps reducing costs and time is up to the debtor and their exact situation.
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by Dulocracy » Thu Dec 10, 2015 4:07 pm

JupiterJones wrote:
And that's because the method that is "most financially beneficial" depends on your definition of the terms. If, by "financially beneficial", you mean "minimizes total interest paid and time to pay off", then the highest-interest-first method does indeed win.

Yes, I did define most financially beneficial as the option that minimizes total interest paid and time to pay off both.

But if you define it as "frees up some amount of discretionary income the fastest", then the debt snowball wins. That's a perfectly valid metric to use too, and the difference in total interest paid can very well be worth the price for the benefit (and it is a benefit) of increased cash flow.

You will note that I also commented that there was an exception if an individual had cash flow issues, which OP obviously does not have.

I often use the analogy of a plane taking off. The pilot can choose different takeoff angles (or speeds, really--they're basically the same thing). The one that typically gets chosen is not the one that necessarily minimizes fuel costs or travel time. It's the one that gets as much distance between the plane and the ground as fast as possible, thus minimizing risk. In the event of anything going wrong, your altitude is your margin-of-safety. Obviously, reducing risk trumps reducing costs and time when it comes to plane travel!

Same with the debt snowball. It doesn't necessarily save you the most money or time, but it does minimize risk. In the event of anything going wrong (job loss, health emergency, etc)., the fewer number of bills you're on the hook for, the higher your "altitude"--your margin-of-safety. Whether reducing risk trumps reducing costs and time is up to the debtor and their exact situation.

I like your analagy to a point. In this case, OP has flat ground, no trees, no crosswinds, and OP is looking to maximize profit on the payload. You are correct that this method would reduce cash-flow risk. It does not, however, minimize risk.

Switching color to change analogy a bit. What if his plane takes off at too steep an angle and stalls? In other words, there are other risks. Also not important for OP as it likely will not be an issue, but others may consider that having the house paid off faster will allow them greater financial security sooner than if they delayed paying off the house. The house is a larger, appreciating asset, which means it would be more devastating to lose. If you are looking at risk, having it paid off is a greater benefit than having the car paid off. For that reason, I would respectfully disagree that paying off the car is better at minimizing risk. It is better at minimizing short term cash flow risk.


I did not go into that much, because for OP, that does not seem to be the main issue. (Change of color to green because :moneybag ) Again, paying off the house is most financially beneficial. It minimizes total interest paid and time until OP is completely debt free. Also again, the difference is so little that it is not going to be the decision OP looks back on and regrets on OP's death bed, whichever way OP decides to go.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.

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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by We'll See » Thu Dec 10, 2015 6:57 pm

I wouldn't pay off either any faster than the minimums. At those rates you would be better off putting your money in 5 yr CDs earning 2% or more.

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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by fnmix » Sat Sep 10, 2016 5:38 pm

[This is reply to book-end an old post]

It is not 9 months later. I had decided to pay-off the car-loan first and I just did. The remaining mortgage (~$150K) is now in sharp focus - all my incremental $s will be headed over there.

I learned a fair bit in reading through and executing on the above thread:
- I find that I do a better job of saving when I keep a single near/mid-term goal in mind (anything that requires 6mos to 24 mos of focus)
- I also found the airplane analogy interesting. There are many ways to take off and many ways to chart a course to a destination. Some of these methods/paths are clearly safe and as long as I can pick one of these, I find that I am satisfied with the end result.

Thanks again everybody for your help.
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fnmix
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by fnmix » Thu Oct 12, 2017 5:06 pm

It's been ~2 years since the original post on this thread and ~1 years since I paid off the car - based on the discussion on this thread. I am happy to report that I have now paid off the house as well.

I am debt free, with the exception of credit cards that I pay off at the end of each month. It is a bit of a relief to not owe money to anybody.

In closing on the this topic, I wanted to thank all the folks who engaged in the original discussion. peterinjapan, watty, harrys, dharrythomas, grettman, knpstr, Nova Lurker, JupiterJones, quantandhold, BolderBoy, Dulocracy, grabiner, we'll see - THANK YOU!
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JupiterJones
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by JupiterJones » Fri Oct 13, 2017 9:29 am

Thanks for the follow-up report, and congrats! :sharebeer
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ze233
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by ze233 » Fri Oct 13, 2017 1:26 pm

You wiped out $180K of debt in 2 years. Kudos to you and thanks for the update, very inspiring. :sharebeer

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fnmix
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Re: Pay-off Car Loan or Pay-down Mortgage?

Post by fnmix » Sat Oct 14, 2017 7:52 am

JupiterJones wrote:
Fri Oct 13, 2017 9:29 am
Thanks for the follow-up report, and congrats! :sharebeer
Thank you again JuipterJones
ze233 wrote:
Fri Oct 13, 2017 1:26 pm
You wiped out $180K of debt in 2 years. Kudos to you and thanks for the update, very inspiring. :sharebeer
Thank you ze233. I found that the combination of LBYM while shooting for a goal is very powerful. Strange as it may sound, I never totaled up the total savings required. I did however (indefinitely) postpone some optional home improvement projects and converted (nice) vacation plans to modest outings in the local area It didn't feel right to do either (more) expensive thing while carrying debt. Finally, modest bonus payouts over the two years put me over the top.
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